Public companies continue to face a massive onslaught of merger and acquisition (M&A) litigation, with shareholders challenging 82% of M&A deals. Unsurprisingly, private companies are experiencing similar highs. This trend concerns management teams and boards of various companies, especially late-stage companies that have gone public via a traditional initial public offering (IPO). In this post, we share widespread M&A risks and post-acquisition insurance policies that offer solutions to these unique issues.
For many company leaders, the period after a corporate transaction might seem like the time to find a reprieve. Navigating a successful acquisition requires laser focus and plenty of energy output, after all. And having the safety of a parent company as a corporate shelter might feel comfortable.
Directors & Officers Liability
However, before diving into coverage details, let’s review the many risks directors and officers face, specifically after an acquisition. Consider this scenario: a board member is sued for actions taken on behalf of the company (entity) before it was acquired.
Although it seems that perhaps the parent company should take responsibility for the lawsuit, that’s not precisely how it works. Many acquired companies terminate their D&O policy when the corporate transaction is complete, and thus, nullifying any D&O coverage after that. This decision forces directors and officers to face massive exposure.
However, post-acquisition risks run high for many years after the deal is done. A plaintiff can file a suit several years after the alleged wrongdoing occurred — up to six years. This time frame is known as the “statute of limitations.” For some industries, it’s not uncommon for lawsuits to surface late.
Furthermore, the allegations can run the gamut, from breaches of the purchase agreement to inaccurate seller representations. These issues can quickly morph into costly lawsuits, muddying the exit and extending the negotiation period. Traditional representation and warranties (R&W) insurance works to mitigate these risks — we go into details about R&W later in this post.
Change in Control
When the material ownership of a company changes, it typically impacts everyone involved with the business. From stakeholders to employees, the management shifts could feel like a slight tickle or a massive flood. And directors and officers are in for huge issues if something goes awry, such as accusations of wrongful acts.
However, a few things to remember about this arrangement are that it usually includes executive employment agreements and creditor pacts. These details of any change in control protect investors and company leaders alike. While new professional relationships are forged, several changes might occur in corporate structure, operational strategy, debt capacity, to name a few.
Events sometimes happen before a commercial insurance policy is purchased, typically resulting in claim denial. However, prior acts coverage is a liability policy specifically designed to protect companies from repercussions for pre-acquisition activities causing injury or damage to others. As imagined, directors and officers are vulnerable to these types of claims, making a runoff policy even more critical.
Prior acts policies usually have a retroactive date, dictating when the coverage actually begins. The insurer will cover events that happen after that retroactive date — even if another insurer covered the business at the time. Each policy is different, so it’s vital to know the details.
Although mergers and acquisitions can be exciting and profitable, they’re also highly complicated. As mentioned, company directors and officers face plenty of scrutinies before, during, and after the corporate transaction is complete.
Some policies kick in to provide coverage for claims made before the change in control. However, some allegations point to a timeframe before and after the corporate handoff. These particular cases are called “straddle claims.” Many times, leaders are puzzled about how directors and officers are covered in these situations.
For example, many leaders might wonder if the problem falls under the D&O go-forward policy or the D&O runoff policy Leaders must work closely with their insurance specialists to sort out these complicated circumstances.
Mitigation Strategies for Post-Acquisition Risks
With such high stakes for sellers and buyers, M&A litigation is astronomical in both the number of cases and settlement amounts. Besides navigating M&A litigation, directors and officers must also face a litigious society and potentially unhappy shareholders. The following are some of the most beneficial insurance policies to protect acquired companies and their leaders.
Every seller and buyer hopes for a smooth corporate transaction — but this desired scenario rarely occurs. As mentioned above, seller fraud, incorrect calculation, and breaches of purchase agreements can derail a deal.
However, R&W insurance responds to these issues by protecting sellers and buyers from costly litigation, providing capital for legal fees and settlements. Not only does this insurance solution give a cleaner and faster exit for companies, but it also serves as an excellent negotiating tool.
Errors & Omissions
Errors and omissions (E&O) is also known as professional liability insurance. Many individuals also commonly refer to it as “malpractice” insurance. This coverage only focuses on financial loss, so companies neck-deep in mergers or acquisitions benefit significantly from this protection.
E&O insurance covers third-party financial loss arising from two factors: 1.) the insured’s product or service’s substandard performance and 2.) an insured’s act, error, or omission during the performance of client services.
Post-acquisition companies endure plenty of changes, such as in leadership, operational practices, benefits, etc. Clients could easily slip through the cracks of all these transitions. As a result, E&O insurance responds to claims alleging financial loss to a third party.
Companies of all sizes, pre- and post-acquisition, face foundational risks that come with running a business. What happens if an employee accidentally nudges a client’s laptop off the corner of a desk? Or, perhaps a vendor falls in your facility when delivering inventory. Consider the ever-famous “slip-and-fall” claims we’ve all seen blasting the headlines. However, these general liability (GL) insurance claims are only the tip of the iceberg.
This helpful policy is the basis of any robust risk management plan. A GL policy protects companies against third-party lawsuits involving bodily injury and personal or property damage. Defense costs and advertising injuries are costly, carving away at your company’s profits—general liability insurance guards against these prevalent vulnerabilities.
Employment Practices Liability
Even though much of the American workforce has shifted to remote work, employment practices claims still surface regularly. Recent social movements have only increased these lawsuits in the US. Discrimination, harassment, and wage and hour disputes are widespread — and easy for employees to file. After all, the American government is well-known for funneling its workforce toward litigation.
Post-acquisition companies typically have loads more employment practices risks to navigate. With so many changes taking place, employees could quickly become offended by new leadership actions, claiming their rights have been violated. Employment practices liability insurance (EPL or EPLI) covers businesses against claims that allege employers have violated their workers’ employment rights.
Many companies sponsor employee benefits plans, helping to attract new talent to their workforce. Consider the benefits of 401(k) plans, employee stock ownership plans (ESOPs), welfare plans, and pension plans, to name a few. Benefits plan administrators are undoubtedly fiduciaries; however, companies sponsoring the employee benefits plan also must accept fiduciary responsibility.
If the plan administrator miscalculates, mishandles, or practices improper plan care, employees will blame all parties involved, including their employer. Fiduciary liability insurance is optional, unlike an ERISA Fiduciary Bond, which is required by law. This policy protects companies from legal liability as it relates to employee benefits plan sponsorship. It covers defense costs, judgments, or settlements against the company.
Shareholders, investors, competitors, and more, can file lawsuits against companies and their executives. Legal cases can harm executives’ reputations, but more importantly, these specific lawsuits can put executives’ personal assets at stake and wreak havoc on a company’s balance sheet.
Most allegations relate to wrongful acts managing the business, and it costs companies and their executives a hefty amount of money to defend themselves. However, directors and officers (D&O) insurance protects board members and management teams. Here’s what a D&O policy typically covers:
- Side A: Protects solely the individual directors by paying the defense costs and settlements levied on the directors as a result of a lawsuit. Side A will only pay the individual directors when the entity is unable (i.e., insolvent) or legally not permitted to do so. Typically, individual directors will ensure that the company purchases additional Side A coverage on top of the traditional ABC coverage.
- Side B: Indemnifies the entity after the entity has paid the individuals named in the lawsuit.
- Side C: This is entity coverage. Should the entity be named along with the individual directors in a lawsuit, this coverage protects the balance sheet of the company and will reimburse and costs/settlements incurred.
D&O Tail Coverage
While R&W coverage and D&O policies are critical, they do present one problem: they only cover a specific time frame. If someone decides to sue a company or its executives after the policy term has ended — which they often do — it could create vast amounts of post-acquisition litigation.
Tail insurance offers a solution to this unique dilemma by extending your existing insurance policy. This extension allows you to report claims post-acquisition for alleged wrongdoings that happened before the corporate transition closed, which is when coverage ends typically. Unsurprisingly, many executives understand that D&O coverage is vital (and usually necessary) for a successful merger or acquisition. However, this coverage often drops off once the parent company takes over.
Unfortunately, post-acquisition is the most popular time for D&O lawsuits to surface. As a result, tail coverage offers insureds an additional three to six years of protection. Tail coverage is more commonly known as an extended reporting period (ERP). It provides the insured with an extended time to report a claim that occurred during the policy period, and thus, meeting the coverage requirements under a claims-made policy.
Who Needs a Tail Policy?
Nearly every company can benefit from a tail policy; however, late-stage companies and special purpose acquisition companies (SPACs) are first to benefit from such coverage. Most claims-made insurance coverages offer tail policies, such as professional liability (also known as errors and omissions) and employment practices liability insurance. In this post, we mainly focus on D&O coverage and R&W policies.
Late-stage companies are well-known for demonstrating a high level of viability and typically have a strong market presence. As a result, many are looking forward to an exit, pursuing Series C, D, or later-letter rounds. With more revenue at risk, this strategy often involves mergers and acquisitions, and the path is usually more straightforward for companies at this stage.
Even with a clear path forward, late-stage companies have a lot at stake. Gaining the momentum to achieve an exit requires top talent. Unfortunately, directors and officers are more exposed during these later stages than ever before — going public means facing the scrutiny of the open market.
Like late-stage companies, SPACs face unique risks. To begin, SPACs have a lifetime limitation of two years. A lot can happen in this short amount of time. These companies must locate and acquire a target company or face expiration. Merging with another company typically means adjusting insurance coverages to align with the specific business combination.
It’s not uncommon for target companies to already have several policies in place, including D&O insurance. However, after the IPO, one policy might cover the newly public company. Sadly, a current D&O policy, for example, won’t cover issues that arise after the acquisition but pertain to circumstances before the transaction was complete. Only a D&O tail policy will respond to those situations.
Understanding the details of what coverage your company needs can be a confusing process. Founder Shield specializes in knowing the risks your industry faces 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.
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