Directors and officers of companies are often at risk for lawsuits and other legal actions against them, alleging they mismanaged company assets or failed to uphold fiduciary duties. In the current business landscape, these claims are only increasing. Fortunately, businesses can stay protected with directors and officers (D&O) insurance — but what happens during a change in control, like a merger or acquisition?
What Is D&O Insurance Tail Coverage?
D&O insurance covers a company’s directors and officers from claims made against them regarding their management of business assets. A D&O policy is an important risk management tool that protects your company’s business leaders from personal financial impact in the event of a lawsuit, along with the company itself. This policy is structured in three parts, including:
- Side A: Protects directors and officers from personal liability for claims not indemnified by the company.
- Side B: Reimburses the company for the costs of defending and indemnifying its directors and officers.
- Side C: Covers the company from claims brought directly against it for wrongful acts committed by its directors and officers.
However, if a D&O policy ends after a corporate transaction, such as during a mergers and acquisitions (M&A), your company’s leaders may be at risk. Shareholders could sue their directors for decisions made before the sale. The new owner’s D&O policy will unlikely cover your directors for past actions.
That’s where D&O insurance tail coverage comes in. Tail coverage, an extended reporting period (ERP), provides retroactive coverage after a D&O policy expires. It’s generally added to the original D&O policy and offers protection for a specified time after the end of the policy, commonly six years. The extended coverage applies to incidents or wrongful actions that took place while the policy was still in force but for which claims are made after the policy ends.
Suppose a company’s director makes a financial mistake that leads to a misrepresentation of financial data for a company in 2020. The company was sold in an acquisition deal in 2022, and the existing D&O policy lapsed. The new company’s shareholders find out about the past mistake and sue the director for damages. With D&O tail coverage, the director’s personal assets are protected retroactively even though the original D&O policy is no longer in force.
Who Benefits From D&O Insurance Tail Coverage?
The most distinct beneficiaries of D&O tail coverage are the executives of a business in transition. D&O insurance tail coverage protects the existing directors and officers from future claims against them.
Additionally, the transitioning business itself benefits from a D&O extended reporting period. Having D&O tail coverage ensures the business continues to run smoothly after a transition period. With tail coverage, business leaders can focus on managing business assets without worrying about potential lawsuits for past actions.
Some businesses are more likely to need tail coverage than others. Specifically, any company going through a merger, sale, acquisition, or otherwise shifting ownership will want to consider D&O tail coverage to protect the existing directors and officers. Naturally, high-growth startups are prime candidates for D&O tail coverage, mainly because rapid growth often results in M&A activity.
The Importance of D&O Insurance Tail Coverage
D&O insurance tail coverage ERP is imperative for business directors and offices. After all, it helps protect their personal assets if their prior decisions trigger a future lawsuit. This financial protection helps business leaders avoid personal losses if a case related to their work is brought against them.
But D&O coverage isn’t just protecting the personal assets of the directors and other business executives. A D&O policy — and tail coverage — is a critical safeguard for the business. If a director is sued after a business transition, D&O tail coverage helps ensure business continuity by covering legal and defense costs for the director.
Additionally, D&O tail coverage can often be applied to the corporate entity in addition to business executives. However, D&O tail coverage isn’t just vital if a lawsuit is filed. It can also help attract and retain top business leadership talent. The best executives want to work with companies that help protect them — even if the company changes hands.
Cost Factors in D&O Insurance Tail Coverage
The cost of adding D&O tail coverage to an existing D&O policy can vary widely between businesses. Common factors that affect the price of tail coverage include:
- Business size
- Life cycle
- Financial health
- Legal structure
- Claim history
For perspective, a large, publicly traded organization with a history of rocky finances will likely pay much more for coverage than a small startup with ample funding and no history of D&O claims. Additionally, a current D&O insurance premium weighs heavily on tail coverage pricing.
While you can’t easily change your company size or claims history, you can control some cost factors when shopping for D&O tail coverage. Some pricing variables include the length of the tail, retroactive date, and scope of coverage.
The standard length of ERPs for D&O insurance is six years, but you can adjust coverage length to suit your needs. Your scope of coverage can help you keep costs lower by decreasing coverage limits. Plus, you can change the retroactive date when coverage begins.
Adding tail coverage to an existing D&O policy is easiest, but this can potentially lead to locked prices. Like other insurance coverage, it’s worth talking with a commercial insurance broker to help find the right coverage at the best price.
D&O Insurance Tail Coverage Claim Examples
How does D&O tail coverage work in practice? Check out the examples below to see how tail insurance coverage protects directors and officers from lawsuits.
Example 1: Post-Acquisition Lawsuit
A tech startup was acquired by a larger corporation. Following the acquisition, the startup’s D&O insurance policy was set to expire. However, the directors and officers opted for D&O tail coverage.
A year later, allegations of financial misrepresentations emerged from the acquiring company. They claimed that the startup’s financials were embellished at the time of sale, leading to an inflated purchase price. The tail coverage proved beneficial as it protected the former directors and officers against the claims, covering legal defense costs and possible settlements, thereby safeguarding their personal assets.
Example 2: Post-Bankruptcy Claim
A manufacturing firm filed for bankruptcy due to unsustainable debt levels. The company’s directors and officers had previously secured D&O tail coverage in anticipation of potential post-bankruptcy claims.
Two years post-bankruptcy, creditors filed a lawsuit alleging the directors and officers’ mismanagement and poor financial oversight. Thanks to the D&O tail coverage, the executives were protected against these claims, ensuring their personal finances were not endangered by the litigation costs or possible judgments.
Example 3: Post-Retirement Lawsuit
A CEO retired from a pharmaceutical company. Soon afterward, the company experienced a lawsuit alleging regulatory non-compliance during the CEO’s tenure. The plaintiff claimed the company misled regulators about the efficacy of a drug in development.
The retired CEO was protected from personal liability because the company had wisely invested in D&O tail coverage. The policy covered legal defense costs and potential settlements, preserving the CEO’s retirement nest egg against the impact of the litigation.
Whether your business has an upcoming transition or wants safeguards, D&O insurance tail coverage can help protect your business leaders if the current D&O coverage expires.
D&O tail coverage provides essential protection for business leadership if the company goes through an acquisition, merger, or another exit. This protection can even help attract high-quality executives to your firm.
Understanding the details of what coverage your company needs can be confusing. Founder Shield specializes in knowing the risks emerging companies face to make sure you have adequate protection. Feel free to reach out to us, and we’ll walk you through the process of finding the right policy for you.