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D&O – do you need to run off?

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  • D&O – do you need to run off?

Insight

D&O/Management Risks

    A ‘need’ is something that is necessary for an organism to live a healthy life, which, for as enthusiastic as we are about D&O insurance, is something of an ambitious claim.

    As to whether you might ‘want’ run off cover (a desire, wish or aspiration), then it should certainly be given some attention. Market dynamics have always regularly created the sets of circumstances under which the decision to purchase run off cover presents itself. And whilst D&O policies have altered significantly in recent years, the case for run off hasn’t.

    Simply put, run off cover buys a period of time after a specific, often transactional, event, where control and/or ownership passes from one party to another. No pattern of facts is the same for each run off trigger, so the motivations behind the potential desire to purchase may vary on a case by case basis. However, some of the most common features include:

    • on acquisition, the incumbent management group may have departed or lost control of the organisation. However, they were in control of the prior to that point and, as such, are responsible for the actions taken and directions given during this time. This responsibility for alleged or actual wrongful acts does not evaporate and exists for many years after they leave office;
    • even if the directors remain the same, the mechanics of D&O insurance will automatically prevent cover attaching for anything that happened after the event date, in line with the change in the ownership interest;
    • the acquiring party is unlikely to be willing or able to provide a backward-looking indemnity, particularly given that they had no control, influence or interest prior to that point. Indeed, one of the most significant risks under a D&O policy on acquisition is from the purchaser itself. Allegations of misrepresentation during the sale are common claims features, so the idea that one might buy a policy for someone else to use if you sue them isn’t a particularly attractive one;
    • it is fixed. The premium for run off cover is fully earned at inception, so it can’t be cancelled or amended for the duration of the contract. The limit is ringfenced and dedicated to the liability of the management group who were in place up until the time of the transaction;
    • any comfort on directors’ protection post acquisition/event may be uncertain. For example, there may be no assets to back up a promise to indemnify, or complications associated with doing so.

    If the acquisition event occurs during the policy period (which it typically would – a 365 to 1 chance that it wouldn’t) the policy should operate automatically to run off until renewal, with cover for wrongful acts that occurred/allegedly occurred prior to the event date. Insolvency is slightly different, and whilst no specific trigger applies, the appointment of insolvency practitioners removes the ability to commit a wrongful act in the insured capacity. Policy provisions should then exist that pre-price the options available for longer periods, so there is certainty of cost and availability at the start of the policy period should a change in control occur. Straightforward enough? You’d think so, but it’s not always the case. This might be because:

    • not all policies offer run off, and not all insurers will offer any more than 1 year at a time, which can be of limited use;
    • not all policies give any run off or reporting period options at all on an insolvency event. There’s always the question of who pays the premium, but it often comes as an unpleasant surprise when the options available have evaporated;
    • the ability to control the choice varies from contract to contract.

    Run off is often confused with “Extended Reporting Periods” or “Discovery Periods”, and with good reason, because they are essentially the same thing. However, what differs is the trigger, with the latter on a ‘refusal to renew’ (which should be bilateral i.e. at the option of either party).

    Another common confusion is around the overlap with Warranty & Indemnity cover, and the possible substitution of D&O run off for that product. The actuality is that they are distinctly different products, with W&I providing protection for the shareholders (warrantors), as opposed to the managers, and the respective capacities as such. Although a warrantor may also be a director or officer of the company, warranties are typically given in the context of a shareholder rather than a director or officer. Therefore, a D&O policy would not respond to a contractual warranty claim arising under a M&A contract.

    So, in a nutshell, run off provides protection against all the risks the management faced when they were in control of the company, the gist of which may not manifest themselves immediately. And it’s a simple fact that a lot of D&O fiascos involve some M&A activity. How long that risk persists for is largely determined by the statute of limitations applicable in the jurisdiction in which the action is brought, and that’s often where the 6 year period feeds into the narrative. Ultimately, the essence of what drives the desire for run off is the same dynamic that drives the purchase in the first place, and that’s the protection of the individual and his/her assets. Careful inspection is required when selecting D&O insurance to make sure there are no unpleasant surprises in the event of a run off scenario. Of course, you might not need to do this, but you might want to…

    Neil McCarthy

    Written by

    Neil McCarthy

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    MPR Underwriting Limited is a company incorporated in England and Wales. Registered Address: 10th Floor, Chancery Place, 50 Brown Street, Manchester, M2 2JG. Company Number: 10529758. Authorised and regulated by the Financial Conduct Authority.

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