When your company is an M&A target, whether traditional or through a Special-purpose acquisition company (SPAC) business combination, much work must be done to negotiate the merger agreement. Certain insurance requirements are part of the merger agreement and, unsurprisingly, they are often low on the list of negotiation priorities.
In the event of an acquisition, it is customary that the merger agreement requires “tail” (aka runoff) coverage to be purchased for the benefit of the target company’s directors and officers. This tail coverage insures the pre-transaction directors and officers for claims that materialize in a set period of time post-merger arising from pre-transaction acts. Typically, this tail coverage is purchased for a six-year duration and the coverage is generally priced as a percentage of the existing annual premium (e.g. 200-300% of the annual premium).
Often merger agreements cap the cost of the tail coverage (e.g. “In satisfying its obligations pursuant to this Section, the Surviving Corporation will not be obligated to pay premiums in excess of 300% of the amount paid by the Company for coverage for its last full fiscal year.”). Clearly, the intent here is to limit the cost paid for the tail policy. Unfortunately, this can cause issues because the insurers providing the tail insurance are not bound by the merger agreement – they will charge the amount they feel appropriate for the risk even if it exceeds the cap. If a premium cap is set too low, a target company may be forced to purchase less insurance or reduce the breadth of coverage, to comply with the merger agreement. As the insured under the tail policy, it is imperative the target company’s directors and officers consider what in their best interests as this insurance may be the only protection available should indemnification not be available from the acquirer.
In the recent past, this capping of tail premium has not been much of a concern as the going rate for tail coverage was well below the cap set in merger agreements. However, we’ve witnessed the cost of tail coverage increase appreciably in the last 1-2 years reflecting the contraction in the broader D&O market. While a few years ago, costs rarely exceeded 200% of the annual premium for a standard six-year tail, we’re now seeing tail options approaching or exceeding 300%.
Of course, ABD will negotiate the best pricing and terms available in the marketplace on your behalf. We flag this dynamic for you so that in the event your company is exploring options along these lines, you can proactively address this during merger agreement negotiations to ensure that such an agreement provide an adequate cushion given current pricing. Please also note, there may be other requirements (e.g. credit rating minimums, policy language requirements, etc.) that should also be carefully considered.
Your ABD team is always available and eager to discuss these topics with you. Please reach out during the initial M&A negotiations so we can set appropriate tail pricing expectations and discuss any other pertinent language. Tackling this early should allow for smoother tail negotiations and less time spent on insurance when company management needs to be focused on closing the transaction.