D&O Runoff at Exit: The Six-Year Tail That Protects Sellers After a Portfolio Company Changes Hands

What happens to a D&O policy when a company is sold?

A change of control provision converts it. Nearly every D&O policy contains a change in control clause stating that upon a transaction the coverage continues only for wrongful acts committed before the transaction, and that no coverage applies to acts after it. In practice, the policy becomes runoff coverage for the remainder of its term, which might be four months. That is the trap. The policy technically still covers the pre-closing period, but only for claims made during the remaining policy term, and a claims-made policy requires the claim to be made while coverage is in force. A claim arriving eighteen months after closing finds no policy. Nothing was cancelled and nothing was excluded. The reporting window simply closed.

• Change of control converts the policy to cover pre-closing acts only.
• Coverage still requires the claim to be made within the policy period.
• The buyer's new policy will exclude pre-closing acts of the acquired company.
• The company's obligation to indemnify former officers may not survive in usable form.
• The decision must be made before or at closing; most carriers will not offer a tail afterward.

How long should a D&O tail run?

Six years is the market standard, and there is a reason for it. Statutes of limitation for many fiduciary duty, securities, and contract claims run three to six years depending on the jurisdiction and the theory, and claims tied to a transaction frequently surface when the buyer's post-closing results disappoint, which is typically one to three years out. Shorter tails of one, three, or five years are available and are sometimes appropriate for a small deal with a simple capital structure. Longer tails past six years are unusual and expensive. The pricing convention is helpful to know when you are negotiating the purchase agreement: a six year runoff commonly costs in the range of 200 to 300 percent of the expiring annual premium, paid once as a single premium, and it is non-cancellable with no return premium.

• Six years is the standard runoff period for a private company sale.
• Typical single premium: roughly 200 to 300 percent of the expiring annual premium.
• One, three, and five year tails are available at lower cost for simpler situations.
• The premium is fully earned at inception and non-refundable.
• Limits are frozen at inception; there is no reinstatement and no additional annual aggregate.

Who pays for the tail and how is it negotiated?

This is a purchase agreement question, and it is negotiated more often than it is litigated. The most common outcome in middle-market deals is that the tail premium is treated as a transaction expense borne by the seller, deducted from proceeds, because the people it protects are the seller's directors and officers. Buyers sometimes agree to fund it, particularly where the buyer is also acquiring management and wants them protected. What matters more than who pays is that the purchase agreement requires it. Look for a covenant obligating the company to bind a runoff policy at or before closing, specifying the period, the limit, and that the limit be no less than the expiring policy. Without that covenant, the tail becomes an afterthought that someone notices during the closing checklist review, if at all.

How does runoff interact with representations and warranties insurance?

They solve different problems and buyers sometimes conflate them. Representations and warranties insurance protects the buyer, or occasionally the seller, against a breach of the representations made in the purchase agreement, and it is an indemnity for the deal itself. Runoff D&O protects individuals against claims alleging they breached duties in running the company before closing. A single set of facts can trigger both. Suppose pre-closing financial statements were misstated. The buyer claims breach of a financial statements representation, which is the R&W policy's problem. A minority shareholder separately sues the former CEO for breach of fiduciary duty on the same facts, which is the runoff policy's problem. Buying one and skipping the other leaves a real hole, and the two policies should be placed with an eye to how each would respond.

• R&W insurance responds to breaches of purchase agreement representations.
• Runoff D&O responds to claims against individuals for pre-closing management conduct.
• Both can be triggered by the same underlying facts through different claimants.
• Coordinate the R&W retention and the runoff retention so neither is left orphaned.

What should a sponsor confirm before closing?

Run a short checklist on every exit and every add-on acquisition. Confirm the expiring D&O limit and whether the runoff limit should match it or exceed it, since a company that grew substantially during the hold period may have been underinsured in the earlier years the tail now covers. Confirm the runoff policy includes Side A coverage for individuals when indemnification is unavailable, because the selling entity may cease to exist. Confirm the retroactive date reaches back to the beginning of the coverage history, not just to the last policy inception. Confirm any prior acts exclusions from earlier policy changes, which can create a coverage hole in the middle of the hold period. Then confirm the same analysis for the target's other claims-made policies, because employment practices liability, fiduciary liability, and professional liability all present the identical problem and are routinely forgotten.

• Runoff limit at least equal to the expiring limit, higher if the company grew materially.
• Side A protection for individuals when the selling entity cannot indemnify.
• Retroactive date reaching the full coverage history, with no mid-period prior acts gap.
• Runoff placed for EPLI, fiduciary liability, and professional liability as well, not just D&O.
• A purchase agreement covenant requiring the tail to be bound at or before closing.

Ready to address runoff on your next exit?

If you have an exit or an add-on in process, the runoff election is a closing item with a short window. Grandbay Financial Services works with sponsors on transaction insurance including runoff and representations and warranties placements. Book a working session at calendly.com/grandbayfinancial.