Addressing D&O Insurance For The Cannabis Industry

Great opportunities come along in waves. In 1850 it was the gold rush. 1933 brought opportunity at the end of the prohibition. The 1990's the tech boom. Fast forward to today and the marijuana industry is well on its way to becoming the next thriving industry. But, like all companies that are born in the infancy of a new industry, there are significant challenges. For cannabis companies the current challenges are abundant – regulatory uncertainty (compounded by the current administration), potential lack of bankruptcy protections, and an inability to secure credit or bank commercially are the tip of the iceberg. It also takes certain kinds of shareholders to invest, and risk-tolerant executives to run these companies.

While directors and officers insurance exists to provide some insulation from that risk, directors of cannabis companies are often described as desperate for coverage, and for good reason. In the past 3 years FINRA and the SEC issued investor alerts over marijuana related investments, and Lloyds of London announced their ceasing of insurance for the industry. Given the current regulatory environment, many insurers are naturally apprehensive to provide coverage terms. The vast majority of public cannabis companies are also micro or nano-cap companies trading on the OTC market, which in and of itself is already a hard market with a smaller pool of insurers. That pool however only becomes smaller when combined with a challenging industry. This reduced competition among insurers understandably results in inflated premiums and aggressive policy terms often unilaterally dictated by the few carriers that do have interest – often with a “take it or leave it” attitude and little room to negotiate. However, while D&O insurance may be elusive, companies should not make the mistake of assuming that the coverage is entirely unavailable. We also have some advice for the c-suite interested in maximizing their available offerings:

PERFORM DUE DILIGENCE: In one of our prior articles: Addressing the D&O insurance challenges of OTC companies, we provided some advice to smaller public companies seeking D&O. Much of these recommendations also hold true here. Additionally, marijuana companies should clearly and carefully communicate their business operations in as much detail as possible. This is particularly true for those more removed from farming or dispensing operations. In some situations we have seen carriers decrease their initial premium indications after being provided a greater depth of detail regarding their organizations’ operations. At first glance, many companies may appear to be “closer to the plant” than they actually are - for those that are further removed from farming and dispensing, effectively communicating this to the underwriters may soften some concerns and help to open the market or achieve more competitive premiums. When it comes to financing, some cannabis companies are exploring alternative investments such as initial coin offerings. While ICO’s have attracted considerable attention, financing through such vehicles may actually have an adverse effect on the placement of coverage, making insurance even more elusive.

REVIEW CARVE OUTS CAREFULLY: Due to the regulatory environment, most (if not all) D&O proposals will carry some form of a regulatory exclusion. While these may be considered typical for the industry (at least for the time being), policyholders should exercise caution and review them carefully. Consider the reading of one such recent exclusion:

No coverage shall be available under this Policy for any Claim, Interview or Investigation Demand:

  • by or on behalf of, or in the right of, at the behest of, at the direction of, or with the participation of any Regulator in any capacity whatsoever, including but not limited to as receiver, conservator, trustee, liquidator, rehabilitator or similar official with respect to the Company, regardless of in what name or for whom such benefit the Claim is made; or any person or entity against which any Regulator, in any capacity whatsoever, has asserted any claim or demand of whatever nature;
  • based upon, arising out of, directly or indirectly resulting from, in consequence of, or in any way involving any agreements, consents, memoranda of understanding or other agreements with any Regulator or any amendments to any of the foregoing, or any actions required by a Regulator pursuant to the terms and conditions of any of the foregoing; or
  • based upon, arising out of, directly or indirectly resulting from, in consequence of, or in any way involving any loss or reduction of earnings resulting from any agreement with, or action by, any Regulator.

Regulator means “any federal, state or local governmental, quasi-governmental, regulatory or supervisory agency, authority or entity or any affiliate of any of the foregoing, including but not limited to any entity created by any provision of any federal, state or local statute, rule, regulation, ordinance, directive or order”.

While the above exclusion would clearly preclude coverage for regulatory or administrative proceedings (or investigations), the exclusion extends considerably beyond that. Also precluded is coverage for; certain stock drop claims and other regulatory-related claims. If you look even closer however there may be a considerably greater exclusion contained within. The language of this particular exclusion (as outlined above) could conceivably compromise coverage in the event of a bankruptcy. For this reason, it’s important to clarify any questionable language with the insurer, requesting appropriate carve backs or modifications – in this case, carving back securities claims related to regulatory actions, and grooming the language to clarify that such an exclusion would not apply in the event of a bankruptcy. Reviewing policy exclusions is equally critical - particularly those related to bodily injury and property damage, pollution, professional services and intellectual property. Exclusions with broad lead-in language precluding coverage for any claims "for, arising from, or in any way directly or indirectly related to" have the potential of negating coverage for a wide array of claims. Policyholders should attempt to negotiate more favorable (narrower) lead-in language. 

ADDRESS BANKRUPTCY CONCERNS: There is a considerable amount of confusion surrounding bankruptcy protections for cannabis companies. While it appears to depend greatly on the company's operation, there is a general lack of clarity/certainty, however those closer to the actual growing or selling of the plant are most at risk for finding themselves without such bankruptcy protections. This can be particularly concerning for early stage and small public company directors. Considering many public cannabis companies are micro-cap with limited assets, one of the main intentions in securing D&O largely revolves around protecting the directors/officers assets in the event of insolvency. For this reason it is important that any d&o coverage placed has strong side A coverage - and surely no bankruptcy exclusions (explicit or otherwise). Confirming bankruptcy protections are in place and securing a D&O policy with acceptable bankruptcy wording however may not be enough. Based on prior rulings, some courts have ruled that the assets of a D&O policy are property of the bankruptcy trustee/estate which can block or limit the directors from gaining full access to policy limits. While there is available language that can be negotiated to prevent such a mishap, companies in the marijuana industry may be more susceptible to such policy "seizures" due to the grey-area of law within which they operate. Side-A DIC D&O policies however do not carry the same risk of being seized by the courts. For this reason, a separate side-A policy can serve as a critical tool when structuring coverage, and should be considered even at lower limit structures. These policies provide a number of additional advantages as well - the most important being broader "drop down" coverage which effectively fills many of the coverage gaps contained within the underlying policy.

EXPLORE ALTERNATIVE SOLUTIONS: Due to the fact that most cannabis companies generally have very small market caps with limited assets, it is understandable that inflated D&O premiums may be deemed excessive, despite the c-suite understanding the importance of obtaining coverage. In circumstances where 1) there is a complete inability to obtain full-side D&O proposals, or 2) proposal premiums are cost prohibitive, there may be alternative options depending on the goals of the executives. Side A only policies are one such solution, providing a lower-premium alternative for directors primarily concerned with protection in the event of insolvency. Where a full public company D&O policy may hypothetically price at 40k per year, a Side A policy would likely price closer to 20k-30k per year with the same limit. There are however obvious disadvantages to this approach - the most glaring being the lack of much needed balance sheet protection, and the potential for even smaller claims to severely deplete corporate assets.

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