05 May 2023
Navigating the Risks of Mergers and Acquisitions: The Importance of D&O Insurance
As merger and acquisition activity may increase in the coming years, adequate Directors' and Officers' (D&O) insurance is becoming more important.
A merger of two companies, or the acquisition of one by another, brings to the fore many issues for Directors’ & Officers’ on both sides of the transaction.
As per Gallagher’s latest M&A Insurance market report, 2022 saw a drop off from 2021 in terms of M&A activity. However, the lack of IPOs coupled with the number of SPACs failing to find a target means that a glut of money remains readily deployable for some investors.
Could 2023 see a surge in transactions?
Some industry analysts believe that is the case, and this could lead to pressure on buyers or sellers and their board members to push through a deal that may not make sense to all stakeholders.
This can easily lead to D&O claims, with an uptick in shareholder derivative lawsuits, class actions and allegations of violations of securities laws, all of which should be picked up by a well-designed D&O insurance programme.
The amount paid for any given acquisition can give rise to stakeholder dissatisfaction
‘Bump up’ claims (brought by shareholders of the acquired firm, arguing the company was undervalued) essentially remain a tax on any M&A activity in the US. Elsewhere, similar disputes are on the up. The reverse scenario can also lead to claims, whereby the buyer’s side is alleged to have paid too much for an acquisition.
Many D&O policies exclude these types of losses, which makes it vital that cover is adequate should a company engage in any M&A activity.
The regulatory landscape is also changing rapidly
A recent ruling by the European Commission, blocking a takeover despite the target company generating zero revenue from the EU, draws a new line in the sand for global oversight.
No longer is turnover the key driver for anti-competitive behaviour. Member states are now able to make referrals to the regulator when in fear of so called ‘killer acquisitions’ – those which could potentially impact competition across the EU.
Regulatory enquiries can be both time consuming and costly, and adequate D&O protection which pays the fees attached to investigations is vital when the regulator comes knocking.
At Gallagher, we have also seen Insured vs Insured losses start to emerge
In the wake of M&A activity, the new owners can effectively sue their new subsidiary directors and these individuals can seek cover under the parent company policy.
Traditionally, allegations of malpractice on the run up to the deal closing (such as artificially inflating the value of the company) would be picked up under the expired / run-off policy. However, some wrongful acts straddle the two policies in force.
Making sure the respective new and old policies dovetail correctly is crucial when it comes to protecting the company, its board and its balance sheet.
Impact on D&O Coverage
It is commonplace for D&O policy wordings to include ‘transaction’ definitions, sending the policy into run-off on the day the deal closes. Transaction clauses can fluctuate wildly, with some being triggered by administration, insolvency events or a sudden change in who can influence board changes.
The run-off coverage afforded can also differ from one wording to the next, with most policies staying in force until its natural expiry, but only covering wrongful acts committed prior to the transaction date. The expiry date can usually be extended for up to 6 years for an additional premium, but in recent years insurers have scaled back on this cover with an additional 12 months only available.
It is therefore vital for customers to check their D&O policy carefully for these nuances and advise their broker of any corporate transaction, ranging from a small series of fundraising all the way up to a fully-fledged merger or acquisition.
Directors' & Officers' versus Warranties & Indemnities / Representations & Warranties Coverage
Whilst D&O insurance is an essential part of any transaction, Warranty & Indemnity (or Reps & Warranties) insurance should always be considered in addition. Given the unprecedented growth in the M&A market since 2020, some litigation resulting from mistakes made during transaction negotiations is unescapable.
Unlike D&O, W&I insurance actually protects the transaction itself. It covers the warranties given by a seller, allowing the seller to make a clean exit but still enabling the deal to complete. The buyer is the named insured whilst the seller can limit their liability for all warranty breaches, meaning an insurer can effectively step into the seller’s shoes. This can often work in the buyer’s favour too, especially in the case of a management rollover where they would be able to sue a reputable insurer instead of their own employees.
Tax and Contingent risk cover can also be beneficial during an M&A process. Any flagged and quantified tax or legal risks might be insurable, allowing a deal to complete with no price chip or specific seller indemnity.
How do I protect my business?
The best way to find out if you are in need of help or a more comprehensive policy is to ask our team for our expert opinion. We are committed to helping you navigate through the complexities and potential future pitfalls. It is never safe to assume you are fully covered without extensively discussing it with your trusted broker first and preparing for any eventuality.
If you’re coming up to your D&O renewal or if you don’t buy D&O at all, it is crucial that you are aware of any potential exclusions or limitations in your situation and our Gallagher brokers can assess your risk exposure and guide you through the process to give you peace of mind. Our advice is to get this done as early as possible to give yourself the best chance of the most competitive and comprehensive terms available in the market.
It is important to maintain and provide up-to-date financial, operational and structural records to enable Gallagher to represent you in the most suitable, effective and efficient manner as well as for any necessary regulatory provision required in the future.
When risks are increasing with no signs of slowing down in the near future, now is as good a time as any to speak to Gallagher and ensure you are prepared and protected when it comes to both D&O and M&A insurance.
Arthur J. Gallagher (UK) Limited is authorised and regulated by the Financial Conduct Authority. Registered Office: The Walbrook Building, 25 Walbrook, London EC4N 8AW. Registered in England and Wales. Company Number: 119013.