Key Points
- A takeover bid for a company can affect the company's D&O insurance.
- Directors of target companies should know what those effects are - and how they can be mitigated.
You're a director of a listed company. The company has D&O cover. Maybe you have a personal indemnity from the company, as well.
One afternoon, your share price suddenly takes off. It quickly becomes clear that your company is about to be a takeover target.
D&O cover and directors' indemnities are the last thing on your mind.
They shouldn't be.
If successful, the predator not only gains outright control of the company, but also potentially controls the indemnities and D&O policies upon which you may need to rely at some later time.
That is why it is necessary to understand your insurance and indemnity protection, before it is too late to take remedial action.
D&O policies are not all the same
D&O policies vary dramatically between companies and insurers, and over time.
This means that, if you're a director of more than one company, you should not assume that the D&O policy held by Company A is the same as the policy held by Company B. In addition, policies are normally renewed every 12 months: your insurer may be unwilling to offer you the same cover from year to year; it may even be possible to obtain better cover in one year than in the previous year.
The availability of cover changes because of a range of factors, including the state of the law and the insurance market generally.
It is important to understand what your current D&O policy covers. That will reveal what gaps are opened up by the emergence of a takeover bid for the company.
For example, it is common for D&O policies to exclude any claims arising out of the issue of a disclosure document in the context of certain transactions. Such an exclusion could substantially erode the level of protection available to the directors for statements contained in documents issued in connection with the transaction.
It is also not uncommon for D&O policies to exclude certain claims made by the company against the directors or claims made by "major shareholders".
These types of exclusions can present a real risk to the outgoing directors if they lose control of the company through a takeover bid or, in the case of the "major shareholders" exclusion, even where they retain control but the bidder takes a major shareholding and is unhappy with the conduct of the directors during the course of the bid.
It may be possible to negotiate to remove or reduce the impact of these exclusions, either as part of the normal renewal of the D&O policy or, perhaps less ideally, once the potential for a transaction has been identified.
How does a takeover affect my D&O cover?
Generally speaking, D&O cover for target company directors will not apply to wrongful acts committed after a change of control of the company. What this means may vary, depending upon the wording of the policy and the type of transaction. For example, there may be a change of control for the purposes of a policy when a bidder has acquired more than 50 percent of the target company.
D&O policies are "claims made" policies, which means that they only apply to claims which are made or notified to the insurer during the policy period. It may also cover situations where the company or directors become aware of circumstances which could give rise to a claim. If the company notifies the insurer of those circumstances during the policy period, claims that subsequently arise out of those circumstances are treated as having been made during the period of the policy.
A D&O policy will generally have a life of 12 months. Since the incoming bidder will have its own D&O coverage, that means that outgoing directors have a maximum of 12 months within which claims must be made or notified depending on how long the policy had to run at the time of the takeover.
What can I do to protect my position if there is a successful bid?
D&O policies commonly allow for conversion of the policy into a run-off policy.
In the D&O context, run-off cover allows an extended six or seven year period for notification of claims arising from events occurring before the change of control. In order to secure run-off cover, the company pays a "once and for all" premium. This is a multiple of the annual premium.
Of course, the new owner of the company may not see the immediate benefit of paying for an insurance policy for directors who have retired from the board! Therefore, it's a good idea for the run-off policy to be secured and paid for before the new owners take control of the company. In fact, this may be necessary, as company indemnity arrangements should as a matter of course impose an obligation on the company to secure such run-off cover.
Even with a run-off policy, outgoing directors should try to ensure that any claims that are known at the time of the takeover bid are notified to the insurer before the change of control.
There are two reasons for doing this:
- early notification reduces the chance of a dispute about the timing and adequacy of a notification;
- notifying before the takeover is complete reduces the risk that the notification process will be under the control of the successful bidder.
It is also important to remember that directors who do not retire immediately on the change of control will not be covered for any of their actions between that time and their official retirement. In addition, directors who don't retire and who remain on the board will also have no cover under the target company's D&O cover for conduct following the change of control. Such directors should consider whether they are covered under the bidder's D&O policy, bearing in mind that that policy may not cover newly acquired subsidiaries over a certain size or otherwise make alternative arrangements for new D&O cover.
How does a takeover affect my indemnity from the company?
At one level, a takeover should not affect a director's indemnity from the company if that indemnity obligation is contained in a stand-alone indemnity agreement between the company and the director. The indemnity is a contract between the director and the company, and is not normally affected by the identity of the company's shareholders.
It follows that it is important to ensure that the indemnity given by the company is in the form of a stand-alone deed of indemnity, rather than a clause in the company's constitution. That is because a director may enforce a stand-alone deed of indemnity, even if she or he is no longer a director or shareholder in the company.
The contents of the indemnity are also worth checking. There are some statutory limits on a company's ability to indemnify directors and it is important to understand the interaction between the company indemnity and D&O insurance.
For example, the company cannot legally indemnify a director for a breach of duty to the company, but D&O insurance may cover such liabilities.
At the same time, however, there are many useful things that a deed of indemnity, insurance and access can do. It pays to ensure that the indemnity document provides the maximum protection consistent with the law, and that the company is allowed little discretion in deciding whether to comply with its terms. Any discretion left to the company may work against the directors once there is a change of control.
In particular the document that contains the stand-alone indemnity should deal with the director's ability to access company records after the director leaves the company.
It is important that, if the new owners later wind up or deregister the company, the indemnity may be worthless. That is why a run-off policy with the premium pre-paid is essential - and why it may also be appropriate to ensure that any liabilities under the company indemnity are assumed by the acquirer or some other entity in that group going forward.
I'm a director of the bidder, not the target - does any of this affect me?
From the point of view of the bidder company and its directors, some of the same issues may be relevant.
For example, the bid itself is likely to be a major transaction that requires notification under the bidder's D&O policy. The transaction itself may require the bidder to engage in activities that may not be covered under its existing policy (eg. due to a "disclosure document" exclusion and the need for fundraising to pay for the acquisition).
Another concern is the position of the incoming board of the target. They may fall between two stools - covered by neither the bidder's nor the target's D&O policy. This is a matter which may have to be negotiated with the insurer before the incoming board is appointed. Finally, the incoming board should ensure that they are covered by an indemnity going forward.
Conclusion
When dealing with a takeover bid, directors' first duty is to their shareholders. While it is important to get the best deal for shareholders it is also necessary to prepare for other possibilities by ensuring that losing a seat on the board does not leave them exposed to liabilities that could easily be avoided by putting adequate insurance and indemnity protections in place.
For a reminder of the main issues that should be considered, please consult the attached checklist.
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.
