Directors & Officers Liability Risk
Eric Hoffman
May 19, 2024

Directors & Officers Liability Risk in M&As

Directors and Officers Liability (D&O) risk refers to the potential legal and financial exposure faced by individuals serving as directors and officers of an organization including public and private companies, partnerships, and non-profits.

Directors & Officers Liability Risk in Mergers and Acquisitions

Directors and Officers Liability (D&O) risk refers to the potential legal and financial exposure faced by individuals serving as directors and officers of an organization including public and private companies, partnerships, and non-profits. These individuals have fiduciary duties to act in the best interests of the organization and its shareholders. D&O risk arises from allegations of wrongful acts or negligence in fulfilling those duties, leading to lawsuits or regulatory actions.

There are three main types of D&O risk:

1. Directors’ Liability: Directors can be held personally liable for breaches of fiduciary duties such as conflicts of interest, mismanagement, or failure to act in the best interests of the organization.

2. Officers’ Liability: Similarly, officers, such as CEOs, CFOs, and other executives, can be sued for actions perceived as detrimental to the organization, such as misleading financial disclosures or regulatory violations.

3. Corporate Liability: Companies can also face liability for the actions of their directors and officers, either through direct legal action or as a result of damages awarded in lawsuits against individuals.

D&O risk can arise from various sources, including shareholders, employees, regulatory bodies, competitors, or creditors. Common allegations include breach of duty, negligence, securities fraud, insider trading, discrimination, or failure to comply with laws and regulations. Corporate activities that are considered high risk are mergers and acquisitions, IPOs, restructurings, and workforce reductions. The consequences of D&O claims can be severe, including legal costs, damages, settlements, reputational damage, and significant personal financial loss for individual directors and officers.

D&O Liability Risk Management

As a director or officer of an organization, it is important to have strong protections in place to mitigate your exposure to personal liability and financial loss. 

There are three key areas to focus on to mitigate D&O liability risk:

  1. Corporate Governance – The first line of protection is preventing and mitigating potential risks before they escalate into liabilities. An organization should have robust corporate governance practices, including clear delineation of roles and responsibilities for directors and officers, establishing effective oversight mechanisms, and conducting regular risk assessments. Additionally, a company’s organizational documents (i.e. by-laws, articles of association, certification of incorporation) should have language that indemnifies directors and officers “to the fullest extent of the law.” There also could be language referring to D&O insurance and the organization’s ability to enter into indemnification agreements.
  1. D&O Liability Insurance – The organization should maintain a well-structured D&O insurance program to provide financial protection for directors and officers against potential management liability risks. D&O insurance policies are specifically designed to cover defense costs, settlements, and judgments arising from claims alleging wrongful acts or omissions by directors and officers in the performance of their duties. It is important to note that D&O insurance policies are written on a claims-made basis and therefore require specific handling to ensure that coverage responds as intended. Adequate insurance coverage helps mitigate the personal financial risks faced by directors and officers and helps ensure their willingness to serve in leadership roles. 
  1. Personal Indemnification Agreement – As mentioned above, a company’s organizational documents should provide a certain level of indemnification, and D&O insurance coverage lends additional protection but either can change over time and there are instances when additional protection is needed. A personal indemnification agreement is a contract between the individual director or officer and the organization that they serve. A robust personal indemnity agreement provides broad protection so that individuals accused of wrongdoing have the right to hire an attorney at the organization’s expense, to receive advanced legal fees, and to have self-insured retentions paid by the organization.

D&O Risk and Insurance in Mergers and Acquisitions (M&A)

Mergers, acquisitions, and divestitures create significant liability risk for directors and officers, and a D&O insurance policy is a critical tool for protecting deal decision makers from M&A related liability risks. It is important to note that D&O insurance policies are written on a “claims-made” basis and will contain a “Change in Control” clause which both necessitate careful attention and management throughout the deal process.

Claims-made coverage means that the D&O insurance policy covers claims that are made during the policy period, regardless of when the alleged wrongful act occurred. This means that the policy must be active both when the claim is made and when the alleged incident took place subject to the policy’s retroactive date(s).

A Change in Control clause in a D&O insurance policy addresses the implications of a change in ownership or control of the insured company. This clause typically provides coverage extensions or modifications in the event of a change in control, which can occur through mergers, acquisitions, or other transactions. The Change in Control clause in the target company’s D&O insurance policy will stipulate that coverage is only provided up to the point of a majority sale meaning that the policy will continue to its expiration date but only cover claims relating to wrongful acts occurring prior to the change in control. Claims relating to post-closing events will be excluded so alternative coverage is required and can be secured through “run-off” insurance or “tail coverage” which provides an extended reporting period of cover typically up to 7 years.  

In summary, claims-made coverage provides protection for claims made during the policy period, while run-off coverage extends this protection beyond the change in control, ensuring continued coverage for past actions. Both are critical components of D&O insurance, offering comprehensive protection for directors and officers against potential M&A liabilities.

In the context of M&A, the management of the buyer’s and target’s D&O insurance policies depends on various factors such as the terms of the transaction, the structure of the deal, and the preferences of the parties involved. Below is a general overview of what can typically happen to D&O insurance in M&A:

1. Transfer or Cancellation: In some cases, the acquiring company may opt to transfer and assume the existing D&O insurance policies of the target company to ensure continuity of coverage for the directors and officers. Alternatively, the acquiring company might choose to cancel the target company’s D&O policies and replace them with its own coverage.

2. Run-off or Tail Coverage: When a company is acquired or merged, it’s common for the acquiring company to purchase run-off for the D&O policies of the target company. Tail coverage extends the reporting period for potential claims beyond the change in control / expiration date of the existing policies, ensuring that directors and officers remain protected for pre-close wrongful acts during their tenure with the target company.

3. Negotiation of Coverage: During M&A negotiations, the parties need to determine the chosen D&O insurance approach for pre and post-close executives, as well as the applicable scope of coverage, policy limits, and exclusions. This negotiation ensures that pre and post-close directors and officers have adequate protection against potential liabilities arising from the transaction.

4. Warranty & Indemnity Insurance: In some M&A transactions, the acquiring company may purchase warranty & indemnity insurance (W&I) to protect against losses resulting from breaches of representations and warranties made by the target company. D&O insurance may complement the W&I insurance by providing additional coverage for claims related to the actions of directors and officers. For additional information on D&O and W&I insurance for M&A transactions, please follow this link.

5. Post-Closing Considerations: After the completion of the M&A transaction, it is essential for the acquiring company to review and potentially amend their D&O insurance policies to reflect any changes in the corporate structure or business operations resulting from the transaction.

Overall, the handling of D&O insurance in M&A transactions requires careful consideration of various factors to ensure that directors and officers at the target and acquiring companies are adequately protected against potential liabilities before, during, and after the completion of the transaction. Collaboration between legal, financial, and insurance advisors is crucial to navigating these complexities effectively.

ARIA helps directors, officers, and organizations understand their D&O risks and how to manage them safeguarding their interests, maintaining corporate governance standards, and protecting shareholder value.

Eric Hoffman

Eric heads up ARIA, where he utilizes 35+ years of global risk management and insurance experience to help organizations and executives to better understand and manage the risks they face in Korea and abroad.