Tails Of Run Off: Insurance Challenges & Considerations During Acquisitions
When structuring D&O, E&O or Cyber insurance for an acquisition, there are 2 distinct time periods: 1) wrongful acts or incidents that occurred before the acquisition, and 2) those that occur after the acquisition. Most insurers will provide the purchasing company with automatic coverage for newly acquired subsidiaries, however they only agree to provide such coverage for (future) wrongful acts asserted after the acquisition date. What happens if 1 year after the acquisition, a lawsuit is filed against the prior entity or its corporate officers for alleged wrongdoing that occurred 2 years earlier? Such claims would fall squarely on the selling company’s policy. The issue however, is that all professional, management and cyber policies are claims made policies, meaning that the claim must be made and reported during the policy term. If the policy was cancelled before the acquisition, or naturally expired, there is no active policy to tender the claim, therefore there would be no coverage. In order to preserve coverage for such claims, the selling company would need to purchase run off coverage, which simply extends coverage for future claims, alleging prior wrongful acts or incidents (those that may have occurred before the acquisition). Given the long tail nature of claims, it’s not uncommon for a wrongful act to be discovered, and give rise to a claim many years later. Absent a policy tail, defense costs and claim damages for such claims would either need to be paid by the purchasing entity or the directors/officers of the selling company depending on the claim specifics and indemnification agreements in place. The importance of a tail is arguably even greater for target companies with prior claims, due to the potential for future claims that may have similar allegations, but not fully deemed to be interrelated to those prior wrongful acts.
For the acquiring company securing coverage for future wrongful acts, it’s important to review all of the policies to ensure all policy terms are adhered to when adding that subsidiary to existing policies. That includes the D&O policy, cyber policy, E&O, EPLI, and general liability, etc. It’s very likely the newly acquired subsidiary is automatically covered by many of the existing policies, however some policies may require additional underwriting information or contain acquisition thresholds. Those thresholds preclude automatic coverage for large acquisitions by limiting automatic coverage for purchases where the newly acquired subsidiary’s assets account for less than a certain percentage of the parent company’s assets (ranging from 10% to 40%). These thresholds may differ from policy to policy. Even when a newly acquired subsidiary does qualify for automatic coverage, notice should be given to all carriers, requesting the new entity be added as an insured onto each of the respective policies. Lastly, the parent company should also re-review each of the policies in their existing insurance program, considering; 1) whether any limits should be increased, 2) whether there are any policy terms or exclusions that may require grooming, such as the professional services or product defect exclusion, and 3) if all foreign exposures have been addressed through appropriate endorsements and/or or placement of locally admitted policies.
Purchasing policy tails for the target company is a bit more nuanced. To start, given the statute of limitations mentioned above, it’s important to ensure any tail purchased covers the statute of limitations, which is generally 3-6 years. Shorter cyber tails may be sufficient, as most cyber events should be discovered well before the 6 year mark, however it is important that any D&O and E&O policy tails run longer in order to exhaust that statute. The run off coverage should also be non-cancelable, in order to ensure that no parties are able to cancel the policy for a refund, safeguarding coverage for the full term. Where coverage is being tailed from an existing policy, carriers’ terms can differ. Some carriers guarantee tail terms, while others simply have the right to offer such terms (at their discretion). Additionally, carriers may stipulate a time frame in which organizational changes need to be reported – this may range from 30 to 60 days. It important to ensure all policy terms are adhered to. In situations where the incumbent carrier is only able/willing to provide a 1 year tail, another carrier can be approached to sit excess for the 1st year, dropping down to act as the primary carrier for any subsequent years.
There is often some confusion around “extended reporting” coverage. Policies often contain two types of provisions (also known as tails or discovery periods). A true “extended reporting period” provides tail coverage for situations where the insured or insurer decides to cancel or non-renew coverage (for reasons other than non-payment). Run-off coverage on the other hand provides tail coverage for situations where there is a change in control event, such as an acquisition. It’s important not to confuse the two. When able, policyholders should aim to pre-negotiate their ERP’s and run off options when placing or renewing coverage. Any associated premiums are rated on a sliding scale, decreasing slightly each year – so a 1 year tail may cost 150%, where a 6 year may only cost 275%. As an added piece of advice, insureds should also ensure review their D&O policy’s “change in control clause” to ensure it’s not triggered by a filing of insolvency, as that would effectively terminate all coverage for any future alleged wrongful acts after the filing.
If you’re the acquiring company and are considering tailing coverage from the seller’s active policy, remember to carefully review its terms. There’s no point extending coverage from the underlying policy if it contains poor terms - you may be better off looking at alternative carriers, when able. The same holds true if the premium for the tail is excessive. Additionally, in some instances, the target company may not maintain insurance, or the incumbent carrier may refuse to provide run off terms. In such situations, a stand alone tail may be able to be purchased, and carriers can often turn those quotes around very quickly. That said, if opting to purchase a tail from an alternative carrier for premium or coverage reasons, be careful of any prior acts/pending litigation dates and/or new warranty statements that might be required, as these can jeopardize coverage for future claims.
Lastly, executives of the target company should; ensure all indemnification agreements are in order, obtain copies of the parent company's D&O insurance and perform an appropriate coverage assessment, and should consider purchasing a Side A DIC policy tail, in the event that policy limits are exhausted or corporate indemnification fails.