What you should know about D&O or R&W insurance for mergers and acquisitions


There are a variety of issues and conditions that must be addressed when companies merge or when one company acquires another. One aspect of business that is often overlooked is insurance. In particular, liability insurance for directors and officers, also known as D&O insurance, is an essential part of any merger or acquisition and must be carefully considered to avoid significant liability in the future. Companies should not overlook the opportunity for representation and warranty when planning a merger or sale.

This is especially true in the current climate. The merger and acquisition activity since the second half of 2020 has seen unprecedented growth. Some bankers have said the M&A market is in full swing and the number of mergers and acquisitions is “well above the historical norm”.[1] With this heightened M&A activity, litigation arising from the transaction – including shareholder actions – is inevitable. According to Cornerstone Research, 82% of the significant deals announced in 2017 and 2018 were challenged by shareholders, which resulted in something like a deterioration three Lawsuits filed Per challenged deal.[2]

Suffice it to say that the risk and the risk of a merger or acquisition are high for the companies involved, but also for individual executives. This article looks at some of the key insurance issues that decision makers should consider in order to minimize this risk and maximize coverage.

D&O insurance

D&O liability insurance is designed to protect directors and officers when they are identified as individual defendants in actions in their roles as such. The D&O insurance protects the insured against lawsuits from plaintiffs such as employees, shareholders, competitors, investors and customers. Some D&O policies also provide coverage for the company.

D&O guidelines usually cover the legal costs incurred and the amounts paid by the insured in the event of judgments or disbursements. If the directors and officers are entitled to compensation from the company under company statutes or employment contracts, this indemnity obligation is usually financially secured by a D&O policy.

Change of control regulations

D&O insurance policies usually insure against certain “wrongdoings”, as defined in the policy, that the company or other insured persons allegedly commit. These policies often include a change of control provision that limits the coverage available for these “wrongful acts” when the company’s ownership changes. Prior to any merger or acquisition, it is important to review and understand changes in control and reporting requirements in order to maintain, uninterrupted, or provide new coverage.

Changes in control are generally triggered when a specific event occurs (ie, a merger, acquisition, or change in control of voting rights). When this triggering event occurs, coverage under the policies will change. While the change in coverage depends on the specific language of the policy, the rules usually state that the policy does not cover any “wrongdoing” that occurs after the initiating event and only covers actions that occurred prior to the change of control. This means that the policy covers actions and omissions that have occurred in the normal course of business, but not after a change of control, if circumstances (e.g. management, business objectives or other key characteristics of the insured person) have changed. When the triggering event occurs and coverage ends, the policy is put down the drain (see below). Note that the change of control provisions in some D&O policies are even stricter and exclude any cover, even for acts and omissions that occurred prior to the change of control.

Change of control issues are very factual and determined by policy language, business specifications, and applicable law. As such, it’s important to understand these nuances before entering into any deal, especially because deployment, once triggered, can lead to inadvertent loopholes or even remove all D&O coverage.

A change in the control provisions may also include termination conditions, according to which the insured must notify the insurer within a certain period of time (either before or after the conclusion of a deal) in order to maintain cover for the new company. As with all termination obligations in an insurance policy, it is imperative that an insured does not overlook these termination obligations, otherwise there is a risk that the company will lose insurance cover.

Tail or drain cover

D&O insurance policies are usually taken out on the basis of claims for damages. This generally means that the insurance policy covers claims that are made during the term of the policy. As noted above, if a merger or acquisition triggers a change in the control of a policy, claims based on behavior after the transaction date may not be covered until the end of the policy. Claims based on behavior after the transaction date may not be covered for the period (likely a few months after the transaction). This creates a potential shortfall in coverage as the acquiring company’s policies do not respond to pre-transaction behavior on behalf of the directors and officers of the selling company.

How do you then cover pre-transaction conduct claims that are made after the policy expires? The answer is “tail” or “drain”. This coverage extends the D&O insurance policy for a certain period beyond the standard insurance period. In essence, the D&O insurance policy is kept open for a certain number of years to handle claims that may arise after the deal is closed. Typically, the end or discharge period is six years.

Consideration of end or drain coverage is critical as it will protect the directors and officers of the selling company in the event the acquiring company refuses to protect them or is not there to protect them in the event of bankruptcy. Accordingly, purchasing an end or drain policy should be a critical business point for the selling company in any negotiation.

Bump-up clauses

After a merger or acquisition, it is not uncommon for shareholders of the acquired company to bring legal action alleging that the consideration paid for the shares purchased was insufficient and the difference between the amount they received in the transaction and that what they claim for themselves, reclaim the actual value of those stocks. Such a claim can imply the “bump-up” clause found in many D&O guidelines. “Bump-up” provisions are generally found in the definition of the loss of the policy and state that the loss does not include the amounts of any judgment or settlement that represent the amount of consideration paid in connection with the purchase of securities is increased.

While such provisions are common, they vary significantly from policy to policy. For example, many bump-up provisions do not preclude defense costs from being recovered for claims that make under-consideration. Others only apply to claims from certain insurance clauses;[3] and still others apply only if the amount representing the increase in consideration is paid by the insured company and not by a director or officer.[4] It is therefore worth carefully examining the definition of “loss” in a D&O policy both at the time the policy is negotiated and in the context of any claims under the policy.

R&W insurance: coverage for the merger or acquisition itself

While insurance considerations in corporate transactions often focus on ensuring that adequate and available insurance coverage is in place when a company or other insured is exposed to potential liability, coverage also exists for the business itself. This type of insurance is known as R&W insurance. Insurance (Representation and Warranties). As the name suggests, R&W insurance protects a buyer or seller in a corporate transaction such as a merger or acquisition from losses resulting from inaccurate representations or guarantees made by the seller or the target company during the transaction. For example, a buy-side R&W policy can protect the buyer by paying losses if the target company provides inaccurate information, misrepresents information, or fails to disclose certain liabilities. R&W insurance can also mitigate the risk when a seller offers little or no indemnity coverage for the business itself.

Michael Gehren, Mikaela Whitman and Pamela Woods are partners at Pasich LLP, a national insurance recovery law firm. You can be reached at [email protected], [email protected] and [email protected].

[1] “M&A in 2021: An Accelerated Recovery” (February 8, 20201), available at https://www.morganstanley.com/ideas/mergers-and-acquisitions-outlook-2021-rebound-acceleration.

[2] https://www.cornerstone.com/Publications/Reports/Shareholder-Litigation-Involving-Acquisitions-of-Public-Companies-Review-of-2018-M-and-A-Litigation-pdf.

[3] See e.g. B. Genzyme Corp. against Federal Ins. Co., 622 F.3d 62, 72 (1st Cir. 2010) (“Bump-up” rule only applies to insurance clause 3).

[4] See e.g. B. Arch Ins. Co. v Murdock, 2019 WL 2005750, at * 9 (Del. Super. Ct., May 7, 2019) (Definition of loss did not include “an amount representing an increase in consideration paid (or proposed to be paid )). from the policyholder combined with it is Purchase of securities or assets ”).

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