Our Mergers & Acquisitions team provide an essential article discussing D&O policy coverage with Warranties and Indemnities for key decision makers involved in M&A activity.

If you're an executive or key decision-maker involved in Mergers and Acquisitions ("M&A"), this article is essential reading for you. As the M&A landscape evolves, understanding the nuances of transactional risk insurance—specifically Warranties and Indemnities ("W&I") and Directors & Officers ("D&O") insurance—becomes increasingly critical. How these insurances interact, their limitations and their influence on each other can be complex. This article aims to answer the pressing question: "Does My D&O Policy Cover Non-Compliance with W&Is in M&A Transactions?"

Are You Protected?

It used to be typical for the W&Is included in a sale and purchase agreement to be granted by the seller(s) and the buyer only. However, these days it is increasingly common for the management team of the target company to be required to stand behind the "business W&Is", either in the sale and purchase agreement itself or in specific ancillary contracts commonly referred to as "Warranty Management Deeds". It is in such situations that managers often question the extent of their personal liability when granting W&Is as part of an M&A transaction and indeed, whether any existing D&O insurance policy would afford them protection.

It should be noted that W&I insurance provides cover for quite a different set of circumstances than those covered by D&O insurance.

W&I Cover

A W&I insurance policy provides cover in the event there is a breach of a warranty or an indemnity given by the managers of the target company. Pursuant to the terms of the policy, an insured buyer can make a claim against the insurance and recover the loss it has suffered directly from the insurance company without the need to pursue the warranting managers. It is a one-off, non-renewable, "claims made" insurance policy, i.e., it provides cover if the policy is in effect at the time of notice of claim being made.

Most policies have a duration of up to 7 years (for tax and fundamental W&I claims and typically 3 years for business W&I claims) from completion of the underlying transaction. A W&I insurance policy provides cover in the event there is a breach of an Indemnity, or a warranty given by the managers of the target company.

Managers' Liability in a Transaction

Additionally, it is common for managers to limit their liability under the sale and purchase agreement to the greatest extent possible and they often cap their liability for any breach of warranty or indemnity to 1 pound. In practice, this means that all claims for breaches of warranties or indemnities must be made against the insurer if any meaningful recourse is to be obtained.

However, it is important to note that in the event of the managers' fraud, the insurance company (who will bear the burden of proof), may seek retrospective recourse against the fraudulent managers. In contrast, D&O insurance provides cover for any civil liability that a company's directors might incur for errors or omissions in management.

D&O Cover

Whilst a D&O insurance policy is also a "claims made" insurance policy, it is an annual, renewable policy. Additionally, the "insured" is the management team of the company, rather than the purchaser of the target company (or in some circumstances, the sellers of the target company).

Therefore, if the D&O policy is to respond, any claims must be made against the managers themselves. D&O insurance policies do not contain a specific exclusion in respect of non-compliance with warranties or indemnities, but these are not intended to be covered by such a policy. A D&O policy will exclude the insured party's wilful misconduct, but it will advance defence costs, which is of the utmost importance to ensure the best protection during legal proceedings.

D&O Policy Change of Control Clauses

In addition to the above and specifically in the context of an M&A transaction, there is a critical provision included in nearly all D&O insurance policies that must be considered. In the event that a third party acquires more than half of the share capital of a target company (and notwithstanding that a D&O insurance policy benefits a company's management team rather than the company itself), any "change of control clause" will be triggered, resulting in the D&O insurance policy ceasing to offer "go-forward" coverage in respect of all actions of the management team after the date of the transaction.

The triggering of a change of control clause can also cause another significant issue as, subject to the language of the original D&O insurance policy, liability in respect of historic actions prior to the date of the transaction giving rise to the change of control may not necessarily remain insured. Pursuant to the Limitation Act 1980, limitations for various actions founded on tort "shall not be brought after the expiration of six years from the date on which the cause of action accrued" (however it should be noted that whilst the standard time bar period for claims against a D&O insurance policy in England & Wales is six years, for tortious claims where the injured person didn't find out about the issue during this six year period, such period can be supplanted by a three year period running from the date on which the injured person became aware of the issue, subject to a long stop of fifteen years from the date of on which the cause of action accrued – if you are uncertain what time period applies to you, please do reach out to a member of WTW for advice).

What is the Solution?

Fortunately, there is a solution for management teams who are otherwise exposed in these scenarios; this is known as a "Run Off" to the D&O insurance policy. "Run Off" allows the management team of the company to continue to have the level of protection they had before the transaction for the agreed "Run Off" contract period.

As part of the broader commercial and transactional matters that a buyer considers during an M&A transaction, we recommend that a buyer also considers the following with respect to D&O insurance policies:

  • Negotiate the "Run Off" before completion of the acquisition occurs.
  • Pre agree the additional period so that it can be activated in an effective and timely manner.
  • The additional "Run Off" notification period is normally contracted for six years with a minimum recommended period of 48 months.

Complementary Coverages

Each type of policy affords a different range of protections designed to provide cover in different scenarios. That said, these two insurances are complementary in that they provide a full suite of protections for the responsibilities assumed by each of the seller, the buyer, and their respective management teams. To ensure maximum coverage, each type of insurance must be tailored to the specific scenarios, jurisdictions, and sectors in which the companies and underlying management operate.

How Can WTW Help

WTW FINEX has a large team of professionals with extensive W&I and D&O insurance experience. We help organisations navigate liability concerns and address transactional risk. Our priority is to help safeguard the leadership and organisation from significant financial and legal repercussions. Whether you're on the buy-side, sell-side, or part of the management team of a target company, understanding these dynamics will equip you with the knowledge to make more informed decisions during your next M&A venture.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.