D&O Liability Coverage Versus TLPE Insurance
As I’ve written in the past, there are many founders of small- and medium-sized, privately held companies that simply don’t see the need for Directors & Officers (D&O) liability coverage.
I won’t argue the merits of D&O insurance here.
But, the reality is that when those owners try to sell their companies, that lack of coverage will come back to bite them.
Buyers, in this case, will almost certainly require a D&O “tail” policy to make sure the Seller is held liable for any wrongful acts against employees or others – things like human resources issues or fraud – committed before the closing date but that didn’t come to light until after closing.
The Buyer doesn’t want to be held liable or pursued by claimants for incidents that occurred before the purchase. So, they require coverage that extends for up to six years after closing.
Essentially the Buyer is looking for a layer of protection from any potential issues caused by the Seller.
For transactions where the Buyer is carrying Representations and Warranty (R&W) insurance, the D&O tail policy will still be required as many R&W insurance carriers will want to insulate the Buyer’s R&W policy from possibly being used to pay any Seller-related claims that incur financial damages.
A D&O claim could even represent a breach. But, the D&O tail provides protection for the Buyer’s R&W policy. The tail policy will also fit nicely into an R&W insurance deductible.
Here’s the issue:
For transactions under $20M in EV, traditional R&W coverage cannot be used. In this case, I think a new insurance product, Transaction Liability Private Enterprise, is a viable alternative to a D&O tail policy.
TLPE insurance is designed for smaller deals. Retention is only 1% of EV or $10,000, whichever is higher.
It is a Sell-side R&W policy where the Seller, rather than the Buyer, is the policyholder. TLPE policies are triggered when a Buyer submits a written demand for damages from the Seller.
Here are the reasons why I think TLPE insurance can replace a tail policy:
Most post-closing D&O claims actually come from Buyers alleging Sellers misrepresented something about the company. While a D&O tail policy can provide the Seller with some legal defense coverage, these policies specifically exclude contractual liabilities. Therefore, breaches of the purchase and sale agreement will likely be excluded. Buyers sometimes work around this by alleging fraud, which a D&O tail is compelled to defend.
TLPE policies are written specifically for Buyer claims of breaches of the sales contract, so no exclusion workaround is necessary. With TLPE insurance, there is no contractual liability exclusion. This makes TLPE insurance infinitely broader in scope than a D&O tail policy.
Depending on the amount of insurance, a TLPE policy may be less expensive than a D&O tail policy. Both policies generally run for a six-year term.
Of course, for deals above $20M, TLPE insurance isn’t available. When faced with bigger deals, D&O tail insurance, which I feel should piggyback on a traditional R&W policy, is the only option.
If you’d like to discuss TLPE coverage, I’m happy to fill you in on the benefits of this unique insurance product. Please contact me at any time at pstroth@rubiconins.com.