How can directors and officers or professionals be protected from post acquisition claims?

Selling your company does not protect you from future litigation for your previous role. Many business owners mistakenly believe that after they sell their business any problems are the responsibility of the new owner – and business buyers think that old issues are always the sellers responsibility - nothing could be further from the truth.

If you are the seller the question you want to ask yourself is: Are you naked? That is, does the new buyers policy cover you - probably not. Does your old policy (now canceled) cover you - probably not. Unless you have tail coverage, you are naked.

What is Tail Insurance?

Tail insurance is a provision in an errors & omissions or Directors and Officers liability policy which allows claims to be made against the policy after the coverage normally expires. The tail policy can provide coverage for several years after the service was provided or the event giving rise to a claim happened.

Most professional liability and Directors and Officers policies (sometimes referred to as E&O or D&O insurance) cover claims made while the policy is in place. When you sell your company, you usually terminate your coverage. If the policy is terminated, the coverage terminates for both past and future acts. Policies like this are called “claims made” policies because they are valid for claims made during the time the policy is active and provide coverage for acts back to the date that E&O coverage was first purchased. The new owners policy covers any acts by the new owner and the officers of the new business entity.

Why Do I Need a Tail?

When a business is purchased, the E&O policy is usually canceled. Claims made after the policy termination are normally not covered even if they relate to issues that took place before the policy cancellation. Because of this, the professional, director, or officer is subject to liability for any claims. Uncovered claims are a potential problem for both the buyer and seller of a business. This is especially true for the seller in an asset transaction.

The issue of tail coverage is very often overlooked in M&A transactions. This important detail should be addressed in the sale of a professional practice in the Letter Of Intent (LOI) and in the asset purchase agreement. Neither the buyer or seller want to be responsible for pre-closing liabilities (especially unknowable liabilities). The cost of tail insurance to cover these liabilities can be significant and sellers rarely consider this cost when contemplating the sale of their business. The cost can be paid by either the buyer or seller or split between them, but needs to be addressed early in the process.

What Should I do?

If you are contemplating the purchase or sale of a professional services business, you should talk to your P&C insurance provider to ascertain the cost of buying tail coverage. The most likely place to get tail coverage if from the company that you currently use for your regular coverage. By getting information on the cost and availability of coverage you will eliminate surprises that could come up after you have invested time and money in due-diligence. When you negotiate the LOI you should include a provision addressing which party will pay for the coverage.