As a company prepares for an IPO, the last thing to sometimes be considered is the potential of future litigation. Although going public can of course be a very good thing for a company, its directors, its initial investors and its stockholders, there is always the chance that an IPO will not perform as expected. The price paid for an unsuccessful IPO may be more than just monetary, however. Lawsuit upon lawsuit may be filed against the company and its directors and officers (e.g., see Facebook’s post-IPO faceoff with its investors). Furthermore, depending upon the severity of any given problem that could arise, an unsuccessful IPO could also draw the attention of securities regulators. IPO-related litigation and formal or informal investigations can cost millions or more to both defend and resolve.
Due to the possible liabilities that may stem from an IPO, it is important that D&O policy considerations do not fall to the bottom of the priority list when planning for an IPO. One of the worst things that could happen is for the company or its directors to later be surprised to find out it or they are not covered for costs incurred in defending any lawsuits or investigations that could arise. To avoid such a major pitfall, we have compiled a list of top issues concerning D&O policies that — at a minimum — should be considered during the planning for any IPO:
- Retroactive Date Exclusion – Coverage is eliminated for all wrongful acts preceding this date. Therefore, coverage does not include matters arising from pre-offering activity, including activities relating to the road show and preparation of the prospectus. This exclusion should be eliminated, where possible.
- Definition of “Claim” – D&O policies provide coverage for “Claims” made against directors. The Claim definition should therefore be drafted in broad terms and should expressly include coverage for regulatory/SEC investigations, securities claims, employment claims, foreign extradition requests and derivative shareholder claims.
- SEC Investigation Coverage – Coverage for an investigation should be triggered by receipt of a subpoena, an investigative order, or any similar investigative document. The trigger should not hinge on an insured person being identified in the investigative document as a target, because, in reality, individuals are rarely so identified.
- Definition of “Loss” – The broadest possible definition of “Loss” should be sought, and should expressly include coverage for punitive, exemplary and multiplied damages, if permitted, as well penalties in connection with violations of Section 11 and Section 12 of the Securities Act that can sometimes be deemed an uncovered disgorgement/restitution of ill-gotten gain.
- Final Adjudication Clause – To maximize coverage for claims asserting deliberately criminal or fraudulent behavior, which is always excluded from D&O policies, applicability of such exclusion should be conditioned upon the establishment of such conduct by a final, non-appealable adjudication, thereby providing defense costs up until such threshold is met.
- Severability Clause – Coverage for claims is often eliminated where an insured person had knowledge of circumstances that later give rise to such claims, which was not disclosed in the insurance application. To ensure that other insureds that did not have such knowledge can access the policy proceeds in defense of the claim, the policy should include a severability clause, which prevents the carrier from imputing knowledge from one insured to the other.
- Priority of Payments Clause – This clause should be drafted to clearly state that proceeds are paid out first to directors and officers and only afterward to the company. This will prevent a bankruptcy trustee from attempting to “hijack” proceeds owed to the directors, or preclude a company from attempting to similarly limit the directors’ recovery under the policy.
While this list is not exhaustive, it can be used as a starting point of reference. Companies, as well as their directors, should keep in mind that D&O insurance can vary significantly with respect to terms and conditions from carrier to carrier. As with any contract, a more careful review of the exact terms and conditions is necessary.