Directors & Officers Liability Run-Off and its Importance During Acquisitions

In last month’s Nursery Management Today magazine our Associate Director, Jenny Hyde looks at Directors and Officers Run-Off Insurance and explains why it is an important consideration in the sale of your business.

Merger & Acquisition (M&A) activity is particularly buoyant in the childcare market, as we move through 2022.

There is understandably a lot to consider selling your business and insurance is often overlooked, specifically, Directors & Officers Liability insurance (D&O Insurance).

Following the sale of a business, a Director’s responsibility for alleged or actual wrongdoings during their time in charge exists for many years after a sale. Directors & Officers Liability run-off insurance can provide you with protection as it will defend your position should a significant personal liability arise.

So, let’s start at the beginning, what is Directors & Officers Liability Insurance?

D&O Insurance provides protection for Directors and Officers of a company against the cost and expenses of defending an action and civil damages awarded against them personally as a result of a wrongful act. Without this insurance protection, individuals may need to fund their own defence.

Government Departments and Regulators, Shareholders, Customers, Suppliers, Employees and Competitors can all bring legal action against a director.

If you purchase a nursery insurance package policy, D&O Insurance is often included as an optional extra with varying limits. Alternatively, it is available under a separate Management Liability policy, which offers wider covers including Corporate Legal Liability for claims made against the Company and Employment Practice Liability.

D&O Insurance is written on a different basis to many other liability covers such as Employers and Public Liability insurance. Employers’ and Public Liability insurance are written on a ‘claims occurrence’ basis, which means they cover claims that occur during the policy period irrespective of when the claim is made. You may have changed insurer, or closed or sold your business, but the policy in force at the time the incident occurred would still accept a claim, even though the policy has ended.

Directors & Officers Liability insurance is written on a ‘claims made’ basis which covers claims that are discovered and notified during the policy period. If the policy has been lapsed or cancelled and isn’t in place at the time the claim is made, it won’t respond to the claim, regardless of when the wrongful act occurred. This highlights the need to ensure continuity of insurance coverage at all times during the company’s life cycle, even after a sale or close of the company.

So how can you continue to protect individuals following the sale or closure of your business?

D&O Insurance usually contains a Change in Control clause within the policy wording, which is triggered by events such as a change of ownership. Once triggered, the policy will usually only provide indemnity for any Wrongful Act committed before the date of the change. This means that any claims based on conduct after the transaction date will likely not be covered.
The Directors & Officers Liability the sellers have arranged will continue to provide cover for claims made for wrongful acts occurring before the sale date but this will only be provided until the end of the policy period.

D&O run-off cover can then be purchased to protect the business against claims that may be made after this date. Typically, Insurers provide options for 1, 3 or 6 years, with 6 years being recommended, as this is the limitation period of most legal claims.

Alternatively, insurers can offer run-off quotes from the date of sale and this can be offset against a return premium for the unexpired period of insurance. This is often preferable as it allows you to negotiate the purchase of run-off cover as part of the sale transaction.

Directors & Officers Run Off Illustration

As shown in the diagram, the outgoing directors have arranged Directors and Officers Liability run-off policy immediately from the sale date, which will then respond to a claim made after the sale but relating to an alleged wrongful act whilst they were running the business.

This gives the previous Directors peace of mind that they have a policy that they have protection in place should an allegation be made following the sale. Without it, they will need to have the funds available for their own legal defence.

What claims could Directors’ & Officers’ Run-Off Protect you from?

As explained, multiple parties can make an allegation against a current or previous Director of a business. Possible Directors and Officers claims scenarios are detailed below. Remember you don’t have to have done anything wrong for an allegation to be made.

  • The acquiring company accuses the previous directors of negligent and fraudulent misrepresentation of the financial standing of the company. The directors have to defend themselves against the allegation.
  • A Director who has exited the business is named personally by an employee in an unfair dismissal claim.
  • Following the sale of the business, a previous Director set up a new nursery and the company they sold alleges they are diverting its opportunities to their new company.

Sshhh… it’s confidential – When to involve your Insurance Advisor

We understand that when it comes to M&A activity, confidentiality is very important. Remember your insurance advisor understands this and is bound by data-protection laws.
We recommend you discuss any sale plans with insurers in good time. They can advise of potential exposures following the sale. Quotes for Directors & Officers Liability run-off should be arranged before the close of the deal, so it becomes immediately effective upon completion.

By obtaining quotes early, the cost of the policy can be negotiated and paid for as part of the business sale transaction, so the outgoing Directors don’t need to cover the cost of this personally. Many sellers make this a non-negotiable aspect of the deal.

In conclusion, following the sale of your nursery, there are still risks you face from when you were in control of the company, but these may not manifest themselves immediately. Directors & Officers Liability run-off cover provides you with protection against those risks, giving you peace of mind that you will not be left on your own should allegations be made.
You can then go and enjoy whatever comes next for you.