Directors’ and officers’ (D&O) liability insurance plays an essential role in protecting business leaders from personal liability for their decisions. After a company is sold or merges with another company, the original D&O insurance policy expires and the new company’s D&O insurance rarely covers allegations of misconduct that occurred pre-transaction. D&O insurance tail coverage, also referred to as runoff coverage, extends coverage to provide past leaders with protection after a company is sold or merges.

Risk liability in merger and acquisition (M&A) transactions is high and does not end at closing. Shareholder lawsuits that challenge M&A transactions are relatively common. Shareholder litigation generally arises months after an M&A transaction has closed. For example, shareholders may claim that the acquisition was not in the best interests of the company’s shareholders or that the purchase price was inadequate. Directors and officers may be named as individual defendants in these shareholder lawsuits.

Many companies have D&O insurance policies that contain a “Change in Control” provision, which causes the policy to terminate upon the closing of an M&A transaction or other change of control event. It is important that D&O insurance tail coverage be purchased before or concurrently with the closing of an M&A transaction. Once the merger has closed, it is very difficult to purchase tail coverage. Sometimes at the time that companies initially purchase D&O insurance, they will pre-negotiate terms and pricing options for D&O insurance tail coverage to ensure continuity in the event of a future M&A transaction.

A “naked tail” D&O insurance policy is purchased by a company that never had D&O insurance prior to its acquisition. This is most commonly seen in cases of private companies that operated without a D&O insurance policy prior to being acquired.

D&O insurance tail coverage typically lasts for six years after the closing of an M&A transaction. However, the length of the tail coverage can be lower for companies with limited exposure to liability. D&O insurance tail coverage typically costs between 100% to 300% of the annual amount of the target company’s expiring D&O insurance premium.

D&O insurance tail coverage provides protection for alleged wrongful acts committed before a change of control occurred. The definition of “Wrongful Acts” is heavily negotiated. Wrongful acts often include breaches of fiduciary duties, negligence, unintentional errors, and material misstatements and omissions. The retroactive date, which is the earliest point in time that wrongful acts by pre-acquisition directors and officers are covered, is also an important term to negotiate with precision.

D&O insurance tail coverage is distinct from representations and warranties (R&W) insurance. R&W insurance provides coverage for the M&A transaction itself by protecting buyers or sellers from financial losses stemming from breaches of representations or warranties in the merger agreement. R&W insurance policies usually are buyer-side, allowing the buyer to recover losses directly from the insurance company rather than suing the seller.