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India: Companies Act 2013 – Liability of Officers in Respect of Offences Committed Prior to Merger, Amalgamation, etc. – Runoff cover

Sec. 240 of the Companies Act 2013, notified on 7th December 2016 and which is effective from 15th December 2016, reads as under:

Liability of Officers in Respect of Offences Committed Prior to Merger, Amalgamation, etc.

“Sec. 240. Notwithstanding anything in any other law for the time being in force, the liability in respect of offences committed under this Act by the officers in default, of the transferor company prior to its merger, amalgamation or acquisition shall continue after such merger, amalgamation or acquisition.”

It looks like there is no corresponding section to this section under the erstwhile Companies Act. While the new section may not change their legal exposures much, it makes more explicit the liability of the officers in default, of the transferor company prior to its merger, amalgamation or acquisition. It overrides other laws and also any contractual arrangements for waiver of liability in the M&A agreement.

In view of the above and also as a proper risk management tool, it is advisable to consider purchasing runoff D&O (Directors & Officers liability insurance) cover for the merged entity to mitigate impact of adverse consequences.

Runoff Insurance Coverage

The legal exposures for directors and officers remain long after a corporate restructure – be it in the form of merger or acquisition etc. Subject to the relevant laws of limitation, stakeholders affected may take time to assess viability of litigation and quantify their loss and initiate legal action against those responsible.

Assuming a D&O policy is already in force, if a change in control takes place during the period of insurance, while the policy remains active, it provides a limited coverage – protecting directors and officers for only those wrongful acts that occurred prior to the ‘change in control’. D&O polices usually have a ‘change in control’ provision which has the effect of covering wrongful acts up to the effective date of change in control. Coverage will come to an end once the D&O policy period expires. What happens if claims are filed later against the directors and officers of the merged or acquired entity? This is where runoff coverage is useful. It provides uninterrupted coverage keeping the window open for reporting claims during a pre-agreed extended period. It may be noted that runoff insurance provides coverage for claims arising out of only those wrongful acts that occur prior to a merger or acquisition.

D&O policies are issued on the ‘claims made and reported’ basis which means that a claim must be both made against the insured and reported to the insurer during the policy period for coverage to trigger. Due to the ‘claims made and reported’ nature of D&O policy, it is necessary that a policy must be in force at the time a director or officer becomes aware of a circumstance which could lead to a claim and report the same to the insurer for the claim to be considered.

To get some more clarity in this matter, given below is the explanation on runoff provision by the International Risk Management Institute (IRMI)

“runoff Provision

A provision in a claims-made policy stating that the insurer remains liable for claims caused by wrongful acts that took place under an expired or canceled policy, for a certain time period.

For example, consider a policy written with a January 1, 2015-2016, term and a 5-year runoff provision. In this situation, coverage will apply under the runoff provision to all claims caused by wrongful acts committed during the January 1, 2015-2016, policy period that are made against the insured and reported to the insurer from January 1, 2016-2021 (i.e., the 5-year period immediately following the expiration of the January 1, 2015-2016, policy).

Although runoff provisions function in a manner that is identical to extended reporting period (ERP) provisions, there are several differences. First, ERPs are generally written for only 1-year terms, whereas runoff provisions normally encompass multi-year time spans, often as long as 5 years. Second, while ERPs are most frequently purchased when an insured changes from one claims-made insurer to another, runoff provisions are generally used when one insured is acquired by or merges with another. In such instances, the acquired company buys a runoff provision that covers claims associated with wrongful acts that took place prior to the acquisition but are made against the acquired company after it has been acquired.”

(Source: https://www.irmi.com/online/insurance-glossary/terms/r/runoff-provision.aspx)

Following a change in control but before the expiry of an existing D&O policy, runoff cover needs to be negotiated with insurance company and bought to provide uninterrupted protection. Runoff covers are meant to provide directors and officers with coverage for claims, which may arise years after an alleged wrongful act has taken place. Without runoff covers in place, directors and officers are left with no insurance protection against the decisions made in their past roles, and are vulnerable to claims made personally against them. A runoff cover may be purchased as a onetime transaction, where insurers are more inclined to offer discounted rates for multiyear coverage.

(Currently an independent consultant pursuing interest in liability insurance.)

Disclaimer: The information contained and ideas expressed in this article represent only a general overview of subjects covered. It is not intended to be taken as advice regarding any individual situation and should not be relied upon as such. Insurance buyers should consult their insurance and legal advisors regarding specific coverage and/or legal issues.