New Owner Review: Directors and Officers (D&O) Insurance

If the company you bought now has outside investors, a board or lenders watching management decisions, ask your broker about directors and officers (D&O) insurance. Also check whether the seller's D&O stopped covering new decisions when you closed, which is often called run-off. D&O is designed to cover claims that the company's leaders, and usually the company itself, made wrongful management decisions, such as claims from investors, lenders or regulators. This guide is for searchers, search fund CEOs and holding company operators reviewing D&O after closing.

Why would a small private company need D&O?

A seller who owned 100 percent of the business had few people who could sue over management decisions. After an acquisition, that often changes. A search fund adds an investor-majority board. A buyer who used a Small Business Administration (SBA) loan may bring in a minority partner, or the seller may roll over part of the equity. Holding companies add co-investors. Lenders impose covenants and add-on acquisitions bring sellers who keep a minority stake or an earnout.

That creates new claimants: investors who say they were misled in an investor update, minority owners who object to a sale or a dilution, lenders who allege misrepresentation, and regulators investigating the business. Directors who are not employees, including investors on your board, usually want to know their personal assets are protected. The company's governing documents may promise to indemnify them, but that promise is only as good as the company's cash. Whether you need D&O, and how much, is a question for your broker and board, not a fixed rule. D&O for search fund boards and investors covers the board's side in depth.

What does a D&O policy cover?

A D&O policy is usually written on a claims-made basis and is built in three parts, often called sides:

Defense costs are usually paid inside the limit, so legal bills reduce what is left for a settlement. See defense costs inside vs outside limits and occurrence vs claims-made.

What does D&O usually leave out?

D&O is not a catch-all for every claim against the company. Common exclusions and gaps, which vary by form:

• Bodily injury and property damage: handled by general liability and auto.
• Employment claims: usually excluded from D&O and handled by EPLI, whether it is bought separately or in the same package.
• Professional mistakes in your services: handled by professional liability.
• Fraud and illegal profit: usually excluded, often only after a final court ruling, so defense may be paid until then.
• Prior and pending litigation: claims tied to suits or demands that existed before a set date.
• Insured vs insured: claims by one insured against another, such as the company suing its own officer, with carve-backs that vary by form.
• Major shareholder claims: some private company forms exclude claims by owners above a set percentage. In a search fund, where investors may own most of the company, ask whether yours has this.
• Contract, intellectual property and some competition claims: many private company forms exclude breach of contract and intellectual property claims, and some limit antitrust or unfair competition claims, so do not assume a competitor's lawsuit is covered.
• Benefit plan claims: usually handled by separate fiduciary liability insurance.

A commercial umbrella usually does not sit over D&O. Extra limit comes from a higher D&O limit or a separate excess D&O policy.

What happened to the seller's D&O when you closed?

Many D&O policies contain a change in control provision. It is typically triggered by an acquisition, a merger, a sale of more than half the assets or a change in who controls more than half the board. When it triggers, many policies go into run-off: they keep covering claims about conduct before the deal until the policy period ends, but not conduct after it. Some stricter wordings end coverage on the transaction date, and some require notice to the carrier within a set time.

Departing directors often buy a tail on the old policy. In mergers and acquisitions a six-year tail is common, priced as a multiple of the annual premium and usually paid up front, but terms are negotiated and can differ from the expiring policy, including lower limits. Some tails exclude a whole claim if it also involves conduct after closing. Before closing, it is common to report known issues and potential claims to the expiring carrier. See prior acts and tail coverage and stock deal vs asset deal.

Will your new policy cover acts before closing and future add-ons?

Check three dates and one clause on your new policy:

• Retroactive or prior acts date: the earliest date of conduct covered. A new policy for a new company often starts at closing.
• Prior and pending litigation date: claims tied to earlier suits or demands are excluded.
• Policy period: claims must usually be made while the policy is in force and reported during it or within a short window after it ends, as the policy sets out.
• Acquired subsidiary clause: many policies cover a newly acquired company automatically if it is below a size threshold, often measured against your total assets. Larger ones must be reported within a set window and may cost more. Some forms cover only the subsidiary's conduct after the acquisition date, so ask how yours treats an add-on's earlier acts.

If you plan add-ons, read the acquired subsidiary clause before you sign the first letter of intent. See adding a newly acquired company to your policies.

Should D&O, EPLI and crime share one package?

Carriers often sell D&O, EPLI, crime and fiduciary liability together as a management liability package. It means one application and one renewal, and it can cost less than separate policies. The key question is whether the liability lines (D&O, EPLI and fiduciary) share one aggregate limit. Crime usually carries its own separate limit, because it pays the company's own losses rather than claims against it.

A hypothetical example. A search fund buys all the stock of a services company with a board of three investors and the CEO. The seller's D&O goes into run-off at closing. The buyer binds a package with a $2 million limit shared by D&O and EPLI, and a separate crime limit. In year two, a group of former employees brings an employment claim that costs $1.4 million to defend and settle. A few months later, a minority co-investor in an add-on sues the board over the deal terms, and only $600,000 of limit is left for that claim's defense. Separate limits would likely have cost more but could have kept a full D&O limit available for the board claim, and a dedicated Side A limit would add protection for the directors personally if the company could not indemnify them, all subject to the policy wording. See the EPLI review and the crime review.

For pricing context, see what D&O insurance costs. Morrow can review the management liability coverage you inherited, flag gaps and request quotes; any terms depend on carrier underwriting. Ask your deal counsel about indemnification in your governing documents.

Keep reading

• D&O Insurance for Search Fund Boards and Investors
• New Owner Review: Employment Practices Liability (EPLI)
• New Owner Review: Commercial Crime and Employee Theft
• Prior Acts and Tail Coverage After an Acquisition: Who Pays?
• How to Report on Insurance to Your Investors and Board
• All guides for new business owners

Frequently asked questions

Do I need D&O if I own 100 percent of the company?

The need is lower but not zero. Lenders, creditors and regulators can still bring claims about management decisions, though many forms exclude or limit contract and competition claims. The picture changes as soon as you add investors, a board or minority owners in an add-on. Discuss it with your broker as your ownership changes.

Does D&O cover claims from my own investors?

Often yes, because investor claims are a core reason to buy D&O. But insured vs insured wording and, in some private company forms, a major shareholder exclusion can limit coverage when the claimant is also an insured or a large owner. Read those clauses with your broker.

What is a D&O tail, and who pays for it?

A tail, or run-off, lets claims about conduct before a sale be reported after the policy would otherwise end. In acquisitions the seller's side often buys it, commonly for six years and priced as a multiple of the annual premium, with the terms set in the purchase agreement. Ask your deal counsel.

Do I need a new D&O policy if my holding company already has one?

Maybe not, if the holding company policy picks up the add-on under its acquired subsidiary clause. Check the size threshold, the notice window and whether the add-on's conduct before closing is covered, and report the deal to the carrier on time. The add-on's own policy may go into run-off for its earlier acts.

Does D&O cover a claim that I misled investors in an investor update?

It may, if the claim is made during the policy period, falls within the policy's definitions and no exclusion applies. Fraud exclusions often apply only after a final court ruling, so defense may be paid until then. Coverage always depends on the wording.

References

• Hunton Andrews Kurth (via ABA Business Law Today): Four D&O Coverage Issues to Consider in M&A Transactions
• Hunton Andrews Kurth: Five Things to Know About D&O Insurance Tail Coverage
• Skadden: Insurance Considerations for Directors and Officers of Delaware Entities
• Fredrikson and Byron: Search Funds, The Life Cycle

This article is general information, not legal, tax or financial advice, and not a coverage determination. Coverage depends on the actual policy wording, carrier underwriting, your purchase agreement and your contracts. Ask your attorney and accountant about deal and legal questions.