A question that comes up at the time of an IPO is this: Should we place a tail policy on our private company D&O insurance?
Although this is a complex question, the answer is straightforward: No, if you can avoid a past acts date on your public company policy. I’ll use the rest of this article to explain why.
Private versus Public Company D&O Insurance
Private company D&O insurance differs from public company D&O insurance in ways that I’ve discussed in a recent post.
Typically, companies make the switch between these two different types of insurance at the time of an IPO (You can find a link to our guide to this process, here.) The switch is mandatory.
To help give context to the discussion here, it’s important to keep in mind that a characteristic of all D&O insurance policies is that they are claims made policies, meaning that the policy that responds to a claim is the policy that is in place at the time a claim is made.
(This contrasts with occurrence policies. With occurrence policies, the policy that responds is the policy that was in place at the time of the alleged wrongful act.)
A Little Background on Tail Policies
If a claims made policy like a D&O insurance policy is not renewed, then claims that occur after the end of the last policy period go uncovered. Companies that are continuing in business, of course, typically renew their policies.
A time when a policy is typically not renewed is when a company is acquired. This is a time where a “tail policy” (also known as a “run-off policy” might be purchased).
As I explained in an earlier article:
This is where a D&O tail policy is crucial. A tail policy covers what would otherwise be a gap in coverage for Ds and Os after the sale of a company. The gap exists because the D&O policy of the acquiring company will typically not respond on behalf of the selling company’s Ds and Os for claims that arise post-closing that relate to pre-closing activities.
When a tail policy is purchased, the insurance carrier for the selling company agrees to hold open the D&O insurance policy for a specified period of time past the policy’s normal expiration date. In the United States, six years is the standard. In other words, if a claim arises within six years after a company is sold, the selling company’s Ds and Os will be covered under their original D&O insurance policy.
The Argument for Putting a Tail on a Pre-IPO Private Company Policy
Of course, a company doing an IPO isn’t ceasing its business, so why does the tail policy question come up?
The answer is the difference between the private and public form of D&O insurance. These two types of insurance do not cover exactly the same thing.
Most notably for this discussion, the public company form of D&O insurance covers the corporate entity only for securities claims (i.e. a claim alleging violation of laws regulating securities, or a claim brought derivatively on behalf of a securities holder).
As the data bears out, this is a real concern, and the cost to defend and settle this litigation is high.
By contrast, the private company form of D&O insurance covers the corporate entity in a broader set of circumstances than just securities claims.
Since the coverage grants are different, the argument for putting a tail on the private company D&O policy goes like this:
- What if a non-securities claim arises against the corporate entity after the IPO for activities that pre-date the IPO?
- The public company policy will not cover this claim, but a private company policy would have.
- Thus, we should put a six-year tail on the private company policy.
Why a Tail Policy Doesn’t Work in These Situations
The argument I just laid out sounds nice in theory. However, there are a couple of problems with the argument.
First, all private company policies have exclusions for any claims having to do with being a public company.
Thus, even if you put a tail on a private company policy and a claim arises during the six-year tail period, the private company policy will not respond if the claim has anything to do with the IPO or status as a public company.
Moreover, when you put a tail on your private company D&O policy, the carriers handling your go-forward public company policy are likely to put a “past acts” (also known as a “prior acts”) date on the public company policy (the policy that would typically respond to anything having to do with your IPO).
That’s because insurers have a principle that only one insurance policy can respond to a claim.
When a carrier puts a past acts date on a policy, they are putting an exclusion on a policy for all claims related to activities that took place before the past acts date. The past acts date will be the date of the new public company policy, which is to say the IPO.
Now ask yourself this question: If I get sued over statements made in my registration statement, such as misstated financials or really anything having to do with the pre-IPO history of my company as expressed in my S-1 registration statement, what might happen?
It’s obvious: Anything related to disclosures in the registration statement took place before the IPO date. Coverage denied. Thus, companies embarking on an IPO and faced with the question of coverage have to make a choice about what they prioritize; they can’t have perfect continuity between private company and public company D&O insurance.
The choice is between broad coverage for the corporate entity and maximizing coverage for your security claim. In the latter situation, you will want to ensure a past acts date won’t interfere with getting your claim paid.
The Solution: A Policy Without a Past Acts Date
Ideally, your public company D&O policy will not have a past acts date and will respond to any claim that arises during the policy period.
Your broker will begin building your public company D&O insurance policy during the IPO preparation process. Your public company D&O insurance form needs to be in place and ready to respond to any claims before the first trade on the day of your IPO.
So, for example, if you have a claim that comes in the day after your IPO, it’s the public company policy that will respond. Without a past acts date, the carrier will not have the ability to make an argument to deny coverage based on the timing of the activities that are the subject of the claim.
The decision to put a tail on your private company D&O policy is just one of many decisions to be made as you place D&O insurance for an IPO company. Some of the decisions, like whether to put a tail policy on your private company D&O policy, involve non-obvious considerations. (Note: There can be unusual circumstances in which carriers refuse to provide policies without a past acts date; for the reasons discussed above, this puts your company in a potentially difficult situation.) Other decisions are more complex and nuanced. This is why it’s critical that you work with a broker who understands what your coverage priorities are, how securities claims actually work, and how the D&O claims process works, too.