January 9, 2019

M&A Claims: Rep & Warranty or D&O Insurance?

With the explosive growth in Rep & Warranty insurance, people sometimes overlook the fact that D&O policies often come into play when dealing with claims arising out of a deal.  This Woodruff Sawyer blog discusses the role that both types of coverage play in protecting a seller and its directors. This excerpt highlights a situation where the D&O policy provides a critical backstop to an R&W policy:

The predicate of this scenario is a serious breach of a representation given by the seller to the buyer.

It could be argued that some breaches of representations are the result of a lack of board-level oversight or even a pervasive cultural issue perpetrated by the board. Let’s say the board is revealed to have put pressure on managers to find the “cheapest” way to dump toxic waste; and that “cheapest way” was to just throw it in the sea. Could this action by the board also result in a claim under the sellers D&O policy?

First, one should expect the breach of the representation itself will inspire the buyer to sue the seller for the breach if not for actual fraud on the seller’s part. This difficult circumstance is actually fairly common, which is why an RWI policy is so useful. It’s also why the calibration of the limit and scope of the RWI policy is so important. The RWI policy is designed to respond in this situation and in the best case has been structured so that the buyer remains whole notwithstanding the breach. Put differently, up until the RWI policy is exhausted the buyer had not experienced any loss, making a suit against the seller’s directors and officers by the buyer unlikely.

However, let’s say the breach is so terrible that the RWI policy’s limit is exhausted without making the buyer whole. In this case the buyer might decide to sue the seller and the seller’s directors and officers. If the buyer sues the seller’s directors and officers for fraud, typically the seller’s D&O insurance to respond. If the regulators become involved as a result of the fraud and there is risk of fines or criminal prosecution against the seller’s directors and officers, it is likely that the seller’s D&O insurance policy will respond, particularly for the cost of an individual director’s or officer’s legal defense.

The blog points out that this kind of claim might well be brought after the seller’s D&O policy has expired – and illustrates the importance of purchasing tail D&O coverage to protect the seller’s directors from post-closing claims.

John Jenkins