Conversations about entity cover run off often only crystallise when the perceived requirement for cover is most urgent. Unlike with D&O, that dialogue can frequently establish that it isn’t there, and probably wasn’t in the first place. Ask an underwriter why, and there is no textbook response. And whilst it is probably not the most pressing issue in an acquisition event, it can be a rather curious one.
The case for D&O run off is well established and the ‘tag along’ social history of entity cover sometimes led to a ‘drag along’ scenario on run off in some policies, perhaps creating the perception of free availability. Entity cover has typically been included without a charge and seen as less vital, or even irrelevant, compared to D&O cover. As Management Liability (‘ML) policies evolved, automatic options that might have existed to mirror the host D&O language have faded away largely unnoticed. The perceived need for the cover can arise by false association with Warranty and Indemnity insurance, a necessary consideration in any sale. A typical share purchase agreement will contain warranties (statements about the business being sold), given by the seller for the benefit of the buyer. They provide the buyer with a remedy (a claim for breach of warranty) if the statements prove to be incorrect. An indemnity is a promise made by the seller to reimburse the buyer for a specific liability, should it arise. Broadly speaking, the purpose of an indemnity in an acquisition is to shift the risk of a particular matter to the seller, and to allow the buyer to recover in respect of that matter. Vitally, the warranties and indemnities are given by the shareholders and are contractual, so are outside of the scope of a ML policy. Notwithstanding this, that process does remove a lot of risk and any known or potential litigation will be disclosed or identified through the process.
As a general observation, there is no rule that a purchaser becomes liable for the seller’s obligations simply by reason of that purchase, but the purchaser may choose to assume the liabilities as part of the deal. Whether it is fair to impose successor liability can involve broad equitable considerations and is often not easy to decipher. One organisation acquiring another through a share purchase “steps into the shoes” of the other company and the buyer often takes on the seller’s debts and obligations, including litigation, both known and unknown at the time of the sale. So, the residual focus (and exposure to risk) in the context of run off is on risks that are within scope of entity cover, but which are unknown and which manifest after the acquisition. Due diligence will help, but it is not foolproof, and the specifics will vary from case to case, making a standardised approach difficult, unlike the position on D&O.
There is added complexity around the question of how run off cover might be triggered. Reporting provisions may make it difficult for a new owner to notify a policy they did not buy, are not a party to and which, ostensibly, exists for the benefit of the outgoing board of directors. Questions of policy access, notification, and insurable interest aside, there may well be little incentive on the part of the former directors to place the cover for fear of contamination of their limit. After all, it was they who bought the policy with their own protection in mind and they may not have even wanted entity cover in the first place. Given a conscious choice, the chances are they might not opt for run off anyway.
What is clear is that a clear answer is difficult to find. Entity cover was a confected embellishment to a D&O policy, not driven by demand necessarily, but created to make an existing product more attractive. It has never existed in isolation, simply because of what it was created to be. For an insurer to make run off automatically available therefore makes little sense, not least because it was likely to be free of charge (100% of nothing is nothing, after all). The conclusion seems to be that there is no technical reason why run off for entity cover cannot be given, but quite what you would get for your money, if anything, is less clear. So, it perhaps not so much a case of not being able to run off, rather that there appears to be no obvious reason and an unclear destination.
