Subsidiary Formation and Acquisition Provisions
May 3, 2011
The corporate entity rarely exists in a static state. The company may have opportunities for expansion through acquisitions of other outside entities. It may be necessary or desirable to form new subsidiaries, and these subsidiaries may also seek to take advantage of acquisition opportunities. Most D&O policies impose specific restrictions or special reporting requirements when insureds engage in this type of activity.
Subsidiary Formation/Acquisition
Most policy forms extend coverage to directors and officers of the parent corporation's subsidiaries. The term subsidiary is generally defined as entities in which more than 50 percent of the voting stock is owned or controlled by the insured corporation.
Most policy forms also extend the definition of subsidiary to include coverage for directors and officers of indirectly owned subsidiaries. Indirect interest in a subsidiary would include the parent's ownership through one of the corporation's other subsidiaries, as is provided in the following definition. When the policy does not provide this desirable extension, the insurer may provide clarification by endorsement.
M. Subsidiary means any entity of which the Insured Organization, either directly or indirectly, or through one or more of its Subsidiaries:
1. Owns more than fifty percent (50%) of the voting stock; or
2. Has the right to elect or appoint more than fifty percent (50%) of the voting directors.
A Subsidiary ceases to be a Subsidiary when the Insured Organization no longer owns more than fifty percent (50%) of the voting stock, or no longer has the right to elect or appoint more than fifty percent (50%) of the voting directors, either directly or indirectly, or through one or more of its Subsidiaries.
RSUI Indemnity Co., RSG 241001 (02/04)
Most D&O policy forms require the insured to report to the insurer transactions involving the formation or acquisition of a subsidiary after the inception date of the policy. Normally this procedure is also required for mergers where the corporation remains as the surviving entity.
While some policies will extend coverage only to newly created entities upon the insurer's express approval to do so, other policies automatically attach coverage under certain conditions. In the following example, coverage is automatically provided and requires no reporting if assets of the new entity are below a specified percentage of total assets of the parent organization. When larger entities are created or acquired, the insured must report to the insurer, in which case the insurer may charge an additional premium.
1. Acquisition or Creation of Another Organization
If before or during the “policy period” the “company”:
a. Acquires securities or voting rights in another organization or creates another organization, which as a result of such acquisition or creation becomes a “subsidiary”; or
b. Acquires any organization by merger into or consolidation with the “company';
the “insured persons” of such organization will be covered under this Policy, but only with respect to “wrongful acts” which occurred after such acquisition or creation. If the fair market value of all cash, securities, assumed liabilities and other consideration paid by the “named company” during the “policy period” for any such acquisition exceeds 10% of the total assets of the “named company” as reflected in the “named company's” most recent audited consolidated financial statements prior to such acquisition, the “named company”, as a condition precedent to coverage for any new “insured person”, must give written notice of such acquisition or assumption to us as soon as practicable, but in no event more than ninety (90) days after the effective date of such acquisition or assumption, together with such information that we may require, and must pay any additional premium required by us.
Insurance Services Office, MP 00 01 (04/03)
Note that coverage for directors and officers of an acquired or newly formed subsidiary is for wrongful acts committed or attempted only after its acquisition or creation. There is typically no coverage for claims based on wrongful acts occurring prior to the formation or acquisition unless specific arrangements are made with the insurer to provide such coverage.
Insurers may also retain the option to impose new or different policy terms and conditions upon the new entity, as shown in the following example.
L. ACQUISITIONS
If, during the Policy Period, the Insured Organization acquires or forms a Subsidiary, this Liability Policy will provide coverage for such Subsidiary and its respective Insured Persons subject to all other terms and conditions of this Liability Policy, provided written notice of such acquisition or formation has been given to the Company, and specific application has been submitted on the Company's form in use at the time, together with such documentation and information as the Company may require, all within ninety (90) days after the effective date of such formation or acquisition. Coverage for such Subsidiary shall not be afforded following such 90-day period unless the Company as agreed to provide such coverage, subject to any additional terms and conditions as the Company may require, and the Named Insured has paid the Company any additional premium as may be required by the Company.
The 90-day notice requirement shall not apply provided that: (1) the assets of the acquired or formed Subsidiary do not exceed twenty-five percent (25%) of the total assets of the Insured Organization as reflected in the Insured Organization's most recent fiscal year-end financial statement; or (2) the acquisition or formation occurs less than ninety (90) days prior to the end of the Policy Period.
St. Paul Travelers, LIA-3001 (07-05)
In some cases, the insurer may have no obligation at all to extend coverage to directors and officers of new subsidiaries.
While it may appear a simple task to meet the reporting provisions, problems can arise. The insurer may not be willing to provide coverage for the new subsidiary, or the insurer may accept the exposure only on limited or restricted terms and conditions or at a substantial additional premium.
During any type of acquisition transaction, the surviving entity's D&O policy will normally pick up coverage only for wrongful acts committed after the transaction. The need to provide coverage for prior acts for the absorbed entity must be established, which can often be as complicated and as varied as the nature and mechanics of the transaction itself. For example, there may be contractual requirements for the acquiring entity to provide coverage for displaced officers. It is extremely important to address such problems as far in advance of the transaction as possible. Although the normal practice is to have the acquired entity's insurer provide this coverage, it may be possible to amend or endorse the acquiring corporation's policy to provide the required coverage. Even if the corporation has no express or apparent responsibility to insure this exposure, it is sometimes possible to negotiate coverage under the corporate reimbursement section that would protect the corporation or subsidiary for any latent or contingent indemnification obligations it might actually have.
Whether the transaction is a simple formation of a subsidiary for tax purposes or a major acquisition, the insured should be aware of the requirements and limitations imposed by the policy. Issues surrounding acquisitions or subsidiary formations by the company should always be carefully evaluated with the insurance broker, legal counsel, and all insureds.