Divestitures and Change-of-Control Provisions
January 18, 2017
Most D&O policies contain provisions that affect coverage when the corporation divests of assets or when it is involved in transactions that affect the ownership or control of the entity. While language differs among insurers, most policies contain provisions that deal separately with and distinguish between
•The sale or dissolution of subsidiaries
•Mergers, consolidations, sale of assets, and changes in control of the corporation
Sale or Dissolution of Subsidiaries
Policy conditions that deal with the sale or divestiture of a subsidiary of the corporation are often, but not always, found within a separate policy condition that addresses all divestiture and change-in-control issues. The policy may also address the sale or dissolution of subsidiaries as part of the definition of subsidiary. When a subsidiary is sold or otherwise divested, the policy will normally continue in force for the original parent corporation and for any claims that are brought against the directors and officers of the divested subsidiary. However, coverage is usually limited to claims based on wrongful acts occurring prior to the date of sale of the subsidiary and made against the insured during the policy period. No coverage is provided for wrongful acts occurring after the sale of the subsidiary. The following examples are representative of language found in many policy forms.
Found in “Conditions” Section
If before or during the Policy Period an organization ceases to be a Subsidiary, coverage with respect to such Subsidiary and its Insureds shall apply only with respect to Claims for covered Wrongful Acts taking place prior to the date such organization ceased to be a Subsidiary.
Old Republic Insurance Company, ORUG-82 (1/2008)
Found in Definition of “Subsidiary”
In the event of sale or dissolution of any Subsidiary after the inception date of this Policy, this Policy shall continue to apply to all persons who were Directors or Officers of such Subsidiary with respect to Claims first made during the Policy Period or Discovery Period for Wrongful Acts committed or allegedly committed prior to the time of sale or dissolution. However, in the event of sale, coverage shall cease as of the date of sale for Claims made against the Directors or Officers of such Subsidiary for Wrongful Acts committed or allegedly committed subsequent to the date of sale.
Great American
Mergers, Consolidation, Sale of Assets, Changes in Control
As a general rule, the D&O policy is subject to a variety of conditions and provisions that are actuated when the corporation is involved in one of the following transactions:
•Consolidation of the parent corporation with or into another entity
•Merger of the parent corporation into another entity
•Acquisition of the parent corporation by another entity
•Acquisition of substantially all of the corporation's assets by another entity
•Substantial changes in the ownership of the corporation's voting stock
•The appointment of a receiver or liquidator
•The taking over of the parent corporation by a governmental entity
•If a financial institution, the failure of the entity to continue actively making loans
Policies vary in their treatment of these activities, but where a policy does contain a relevant provision, it is normally some variation of the following.
Change in Control—The policy continues to provide coverage only for wrongful acts prior to the transaction. The policy is not subject to cancellation.
If during the Policy Period:
A.the Named Insured shall consolidate with or merge into, or sell all or substantially all of its assets to any other person or entity or group of persons and/or entities acting in concert;
B.any person or entity or group of persons and/or entities acting in concert shall acquire an amount of the outstanding securities representing more than fifty percent (50%) of the voting power for the election of directors of the Named Insured, or acquires the voting rights of such an amount of such securities; or
C.the appointment of a receiver, conservator, trustee, liquidator or rehabilitator or any similar official for or with respect to the Named Insured;
(any such event referred to herein as a “Transaction”) then, this Policy shall continue in full force and effect as to any Wrongful Act occurring prior to the effective date of the Transaction until the expiration of the Policy Period.
There shall be no coverage afforded by any provision of this Policy for any actual or alleged Wrongful Act after the effective date of the Transaction. This Policy may not be canceled after the effective date of the Transaction and the entire premium for this Policy shall be deemed earned as of such date. The Named Insured shall give the Company written notice of the Transaction as soon as practicable, but not later than thirty (30) days after the effective date of the Transaction.
Scottsdale Indemnity Company, JAI-P-1 (10-07)
The policy immediately terminates with no provision for runoff coverage.
MERGER, CONSOLIDATION OR ACQUISITION:
If, after the Inception Date, the Insured is acquired by, merged with or consolidated into any entity such that the Insured is not the surviving entity, then coverage under this Policy shall cease immediately upon the date of such acquisition, merger or consolidation. For the purpose of Section III. DEFINITIONS L., the date of such acquisition, merger or consolidation shall be deemed the Expiration Date.
Royal Insurance Co., SR 88294 (3/95)
The insured is required to report specified transactions and the insurer retains the option to extend coverage subject to amended terms, conditions, and premium.
If during the Policy Period, the Company creates or acquires a Subsidiary, or acquires any entity by merger, consolidation or otherwise, coverage shall be provided under this Policy for Insured Persons of such new Subsidiary or entity but only with respect to Wrongful Acts occurring after the consummation of such transaction; provided that if the fair value of all cash, securities, assumed indebtedness and other consideration paid by the Company for such new Subsidiary or entity is more than twenty-five percent (25%) (or if greater, the highest percentage in any similar provision in the Underlying Insurance) of the total consolidated assets of the Parent Company as reflected in the Parent Company's most recent audited consolidated financial statements, coverage under this Policy for such Insured Persons is conditioned upon (i) the Insurer receiving written notice of such acquisition or creation within sixty (60) days after the acquisition or creation, and (ii) payment of any additional premium required by the Insurer with respect to such coverage within thirty (30) days after the Insurer requests such additional premium.
Old Republic Insurance Company, ORUG-88 (10/2009)
Policy provisions that provide automatic termination in the event of enumerated transactions with no provision for runoff could cause problems. In most situations, the insured individuals will have ample time to address the need for runoff coverage and will be able to exercise the right to purchase the extended reporting period. Also, in many instances acquisition agreements require that the acquiring entity provide coverage for some specified period of time, usually six years. Certain enumerated transactions or events, however, such as changes in control of voting stock and bankruptcy, are often unplanned events that the corporation may not be able to control. In these situations, it is desirable that the policy continue in force as respects potential future claims that might be brought for wrongful acts taking place prior to the described event. Similar issues and discussions can arise in the context of employment practices liability policies especially where significant pre-or-post transaction reductions in employment are planned or anticipated.
Conclusion
Language addressing change-in-control provisions varies from policy to policy, both in the scope of the transactions that trigger the special provision as well as the actual conditions governing termination or runoff of coverage. The most common provision is that in the event of a change in control, the policy will remain in force for the remainder of the policy period but only as respects claims based on wrongful acts occurring prior to such change in control. What constitutes a change in control can also vary significantly among the various policy forms. In addition, some policies may not fully address the issue of change in control of the corporation or the provision may be ambiguous.
A company should always first identify whether the planned reorganization will trigger or activates the change-in-control provisions of the policy. For example, a Section 11 bankruptcy may not always trigger the change-in-control provision, especially where a trustee has not yet been appointed or the reorganization plan completed. If the reorganization will remain in business action must be taken to ensure that the runoff coverage and any new coverage for the reorganized entity are synchronized to ensure continuity of coverage for both pre-and-post reorganization insureds. This is especially important where there may be a claim or claims that potentially span both pre-and-post reorganization periods.