In insurance parlance, if you insure a particular exposure, you’re covered. If not, you’re bare. If you’re looking for a policy that covers something that’s never been covered before, you’re… naked.
That’s the situation many privately held, small and middle market companies find themselves in when they seek to sell their business.
There are a few reasons you need a D&O Tail policy when you’re going through any M&A deal, besides the fact that it is contractually required. (For those who’ve never had D&O insurance and don’t see why you need it now, pay close attention.)
This is major liquidity event. You become a deep-pocketed individual overnight. There’s nothing like some press release touting the $20M sale of your company to bring people out of the woodwork who are motivated to take some legal action. Could be past competitors (like a company hoping to be purchased but you were selected instead). Also, former employees who quit before the transaction happened and who now feel they want part of the payday. You need to be protected against such situations.
If you don’t have R&W coverage, you have no protection from Buyers alleging you committed fraud or misrepresentation when you affirmed you knew of no potential breaches of the Reps in the Purchase and Sale Agreement. In these cases, they usually want to keep your escrow, and even clawback more funds to pay for the financial damages – up to 100% of the purchase price. That’s not good.
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The Buyer asks for a “tail” policy on D&O insurance to ensure coverage for any wrongful acts, like HR issues or fraud, committed by the Seller before the sale. This protects the Buyer from being liable for incidents, such as lawsuits or complaints, that happened before they acquired the company.
Tail coverage extends D&O, Employment Practices, and Fiduciary Liability for up to six years post-closing and kicks in on the acquisition date. It covers claims related to wrongful acts by the former directors and officers before the purchase.
This is standard in M&A deals and a more affordable alternative to Representations and Warranty (R&W) insurance, typically costing $20K to $50K, with a deductible of $25K to $50K.
Many privately held companies, especially small businesses, never carried D&O insurance but need it to meet acquisition terms. For example, a couple running a business for 20 years without any claims may need to quickly secure a D&O Tail policy when selling.
In the past, insurers required several years of D&O coverage before offering Tail policies, often charging high rates with exclusions for those without prior coverage. Today, insurers recognize the low risk and now offer Naked Tail policies even for small deals, as long as the Seller warrants there are no known claims or issues before closing.
As I mentioned, if you’re looking to sell your business, you’ll most likely be contractually obligated to take out a D&O Tail policy. There’s no getting out of it, so to speak. And with the legal and financial protection it offers, why wouldn’t you want a policy anyway.
I would recommend not going to your regular commercial insurance broker, even one with experience in standard D&O insurance. A Naked Tail policy is a whole other animal.
You need a broker experienced in insuring M&A transactions and Naked Tails in particular. It’s a slightly different skillset. And because this issue usually comes up close to closing, you want a pro who can get the paperwork processed in a day or two.
I’ve worked in this world for years and would love to answer any of your questions about setting up a D&O Tail policy to your deal. It’s low cost and easy to do.
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