Jeff Van Gulick, Practice Leader & Executive Risk Specialist, HUB International
Insuring directors and officers through M&A and IPO events
Corporate transactions including mergers and acquisitions (M&A) and initial public offerings (IPO) bring necessary capital and resources to a growing company. But, these transactions can also be the impetus for legal recourse – a significant liability for the company’s directors and officers.
Mergers and acquisitions can be fairly contentious and not all shareholders agree that it is in their best interest for Company A to buy Company B. An even greater source of contention can be inadequate consideration. While the board has done their due diligence, some shareholders may still argue they didn’t do enough – that they should have received more money from the transaction.
As a result, D&O insurance responds largely to defense costs only, never paying the difference in stock prices. And in the last few years, these cases have prompted D&O insurers to put specific M&A retentions into their policies.
Retention, or self-insured retention, refers to the amount of money an insured business is responsible for paying first in the event of a claim before the insurance kicks in. Retentions make insurance coverage more affordable by reducing the premium costs.
These retentions, which typically cost insured businesses a minimum of $1 million to $1.5 million, come in two forms – a standard M&A retention, which carries a broad classification and could apply to any M&A lawsuit including a breach of fiduciary responsibility or breach of contract, and a merger objection retention, which is targeted specifically to an M&A inadequate consideration suit.
Unlike an auto deductible, D&O policies feature self-insured retentions, or SIRs, that are to be paid upfront before the policy kicks in. A policy with one million dollar merger objection retention, for example, would pick up the claim only after the retention had been paid out and until policy limits have been exhausted.
You want the correct type of M&A retention to be utilized, applying to as few circumstances as possible. It’s up to the broker involved to ensure that the correct exclusionary language is put into the policy.
Do IPOs also necessitate an additional policy?
In 2014, IPO activity grew substantially until it reached its current rate – the highest in the last six years. The greatest liability for D&Os during an IPO comes from the prospectus document that discloses the company’s risks and financials to the public. The information in this document creates absolute liability for a company’s directors and officers and is subject to a three-year statute of limitations.
Traditional D&O coverage will include prospectus liability although a stand-alone prospectus liability policy can be purchased as well. If you stick with a traditional D&O policy you’ll want your broker to negotiate adequate endorsements to cover IPO & SOX exposures, including prospectus liability.
Buying the right limits to cover the business beyond the IPO can be another challenge, as businesses that purchase limits predicated off only the IPO could find themselves without adequate coverage. When in this situation, sit down with a broker to navigate the benchmarking that will ultimately help determine what limits will provide the necessary coverage.
Which D&O coverage option is a good fit?
In general there are three types of D&O coverage – Traditional, Side A and Independent director policies.
Traditional coverage will indemnify the company, its officers and directors.
Side A coverage covers a company’s directors and officers, but not the business itself. Big companies with lots of capital that aren’t worried about insuring the corporation will buy Side A insurance. Side A policies will cover situations where the business can’t indemnify its directors and officers.
Independent director liability (IDL) policies will cover a company’s directors exclusively. In a typical D&O claim, the directors might be concerned about D&O limits left to cover them under a traditional policy. IDL coverage enables companies to attract more experienced, high-powered directors to their board.
What limit level is appropriate?
Getting the limits right for your D&O policy is important and will require an experienced broker to explore as many indicators as possible on your behalf. Brokers should use a variety of different benchmarking metrics – including your litigation history and your company’s market capitalization – to model potential losses and determine optimal D&O policy limits.
Do you have the right international coverage?
Companies that conduct business internationally may no longer be able to use their global master insurance program abroad. Countries like Brazil, for example, are now requiring D&O policies to be purchased locally in order to pay out funds to local executives should a D&O claim arise. These new edicts have already left directors and officers working in foreign subsidiaries high and dry in cases where the company hasn’t purchased local coverage.
About the Author
Jeff Van Gulick is a client executive with HUB International. He is charged with structuring and placing director and officer programs for IPOs, reverse mergers and LBO transactions. He also is responsible for the negotiation and placement of Hub’s executive liability products.