Directors and Officers Liability Insurance (“D&O Insurance”) is often front of mind for any director or senior executive, as it serves to transfer the risk of personal liability arising from the performance of their role to insurance.
This awareness is heightened in the face of an actual or potential merger or acquisition (“M&A”). When considering directors’ and officers’ potential exposures in an M&A context, each transaction party must consider:
Case study: Pacific Current Group Ltd v Fitzpatrick
Just because a new Board has been appointed, or the M&A transaction has completed, does not mean that the risk of personal liability for a director or officer of the acquired or former entity has been diminished. The recent case involving Pacific Current Group Limited (“PCG”) illustrates the longtail nature of directors’ and officers’ liability, particularly for executive directors, and the importance of ensuring adequate D&O Insurance run-off to cover longtail exposures.
The case involved the merger of PCG and Northern Lights Capital Partners (“NLCP”), whereby both companies transferred their assets to a joint unit trust (the “Transaction”). The Transaction completed in November 2014 and by April 2017 the unit trust became wholly owned by PCG. Between 2014 and 2017, the value of NLCP’s assets in the unit trust were written down and by 30 June 2017, PCG (which by that time wholly owned the unit trust) reported a net loss of $48.2million.
In proceedings filed in 2020, PCG alleged that five of the company directors, comprising the managing director and CEO, as well as four non-executive directors (“NEDs”), failed in their duties to conduct property due diligence and asset valuations in relation to NLCP’s assets, and obtain proper shareholder approval for the merger, in breach of both PCG’s constitution and the ASX’s Listing Rules.
While the four NEDs successfully relied on the business judgement rule, the Court stated that as an executive director, it was expected that the managing director and CEO possessed a degree or range of skill higher than what is typically expected from NEDs under the Corporations Act, and in the circumstances of this case, the managing director and CEO breached his duty of care.
The directors involved in the PCG claim held roles at PCG at different times but importantly were all directors at the time of the Transaction. One of the directors retired from the role on the completion date.
In the ordinary course, a director may seek indemnity from the company under any relevant Deed of Indemnity and Access, however the availability of such indemnity will depend on the circumstances. In the case involving PCG, where the company was the party bringing the claim and subject to the terms of the Deed, it is unlikely that indemnity under the Deed would have been available to the directors. In the absence of D&O Insurance, the directors may be required to fund their own defence to any claim, and in the case of the managing director and CEO, may be personally liable for the judgement.
It can be reasonably assumed that a prudent insured, particularly companies the size of PCG and NLCP, held their own D&O Insurance programs pre-Transaction and maintained the coverage in some form post-Transaction. D&O Insurance will typically include a change in control or transaction clause, language which seeks to put the D&O Insurance into immediate ‘run-off’ once a considerable (commonly, more than 50%) change in ownership occurs for the named insured. This can include changes to a majority of shares, voting rights, or board composition and be brought about through the typical M&A process.
Whilst the Transaction in Pacific Current Group Ltd v Fitzpatrick may not have triggered this clause under the existing policies noting the nature of a merge, considerable changes in a company can be reason to strategically procure insurance run-off even without strict engagement of a transaction clause.
The intention of run-off policies is to allow insurers to underwrite a replacement, go-forward D&O Insurance policy for the restructured company and ringfence past liabilities to the D&O Insurance run-off, ordinarily available for a period of up to seven (7) years at insurers discretion. Post-transaction, a D&O Insurance policy should be procured covering the post-transaction directors, to ensure insurance coverage is available for all go-forward incidents that may arise.
Concurrently to this, prudent insureds should explore the necessity of D&O Insurance run-off and affirm insurance coverage for each of the directors engaged pre-transaction to ringfence liabilities away from the go-forward company.
It is paramount that the full range of pre- and post-transaction exposures are understood from an insurability perspective. Insurance due diligence can be utilised to understand the severity of an insurable exposure and provide a succinct action plan to appropriately ringfence pre-transaction risks and ensure that post-transaction risks are adequately insured, providing comfort to each transaction party.
Considering and fully understanding the necessity of D&O Insurance run-off is critical to a smooth transaction. In the case of PCG, strategic D&O Insurance design could have ringfenced appropriate D&O Insurance exposures to preserve subsequent limits for future risks.
In any transaction, the insurance due diligence workstream can identify relevant change in control or transaction clauses in your D&O Insurance, clearly outline an action plan including, where required, procuring D&O Insurance run-off, and affirming the insurability of events pre- and post-transaction. Where D&O Insurance run-off is not procured, there may be a gap in coverage that needs to be understood and accepted by all transaction parties prior to transaction completion.
