How do D&O Change-in-Control exclusions and Section 338(h)(10) elections impact founder closing proceeds?

In an acquisition or financing round, standard D&O policies automatically terminate coverage upon a >50% Change in Control unless a 6-year Run-Off endorsement and Side-A DIC protection are bound—while a buyer-requested IRC Section 338(h)(10) or F-Reorganization election reclassifies seller stock proceeds into 37% ordinary income and triggers state S-Corp entity taxes unless made whole via an iterative Tax Gross-Up.

Why must the Tax Gross-Up Payment be calculated iteratively ("tax-on-tax")?

Because the cash Tax Gross-Up Payment paid by the Buyer to the Seller is itself treated as additional taxable purchase price consideration, a flat reimbursement leaves the Seller ~25% short. An iterative make-whole formula divides the incremental tax differential by (1 - effective tax rate) so the Seller nets 100% of straight stock-sale proceeds.

D&O, R&W Insurance & Section 338(h)(10) PlaybookFree D&O, Management Risk & Founder Proceeds Tool

M&A Section 338(h)(10) Tax Gross-Up & D&O Run-Off Exposure Calculator

Founders face two silent 6-figure traps in M&A and venture transactions: D&O binders that lack Side-A DIC / Insured-vs-Insured carve-outs, and LOIs requiring a Section 338(h)(10) or F-Reorganization election that triggers a $250,000–$850,000+ ordinary-income tax bill at closing. Model your exposure below—then scan your D&O binder or LOI free.

M&A LOI & Section 338(h)(10) Inputs

Headline M&A Enterprise Purchase Price ($)$6,000,000

Purchase Price Allocated to Ordinary-Income / Hot Assets (%)35% ($2,100,000)

State S-Corp Entity-Level Deemed Asset Sale Tax (%)3.5% ($210,000)

Surprise Seller Tax Hit

$567,000

Ordinary income spread + state entity tax

Iterative Tax Gross-Up

+$766,216

Includes tax-on-tax make-whole payment at closing

Founder Proceeds Saved

$766,216

100% buyer-funded Section 338(h)(10) election

Copy-Paste Section 338(h)(10) Seller Tax Gross-Up Covenant

“MANDATORY SECTION 338(h)(10) / F-REORGANIZATION TAX GROSS-UP: Sellers' obligation to join in any election under IRC Section 338(h)(10) or consummate a pre-closing F-Reorganization shall be strictly conditioned upon Buyer paying Sellers at Closing an additional cash Tax Gross-Up Payment (estimated at $766,216) sufficient to place Sellers in the exact net after-tax cash position (including taxes assessed on the Tax Gross-Up Payment itself) that Sellers would have realized had the transaction closed as a straight sale of stock taxed at long-term capital gains rates.”

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DIRECTORS & OFFICERS (D&O), EPLI & MANAGEMENT LIABILITY BINDER

THIS PRIVATE COMPANY MANAGEMENT LIABILITY BINDER ("Policy") is issued by SUMMIT EXECUTIVE UNDERWRITERS ("Carrier") to HERITAGE CLOUD SOLUTIONS INC. ("Company") and its Directors and Officers ("Insured Persons") with a Combined Shared Aggregate Limit of $3,000,000 across D&O and EPLI.

SECTION IV.F. BROAD "INSURED VS. INSURED" EXCLUSION (FOUNDER, FORMER DIRECTOR & TRUSTEE BLOCKADE).
Carrier shall not be liable to make any payment for Loss in connection with any Claim brought or maintained by, on behalf of, or in the right of the Company or any Insured Person (whether current or former) in any capacity. This exclusion applies without carve-out to: (a) wrongful ouster, dilution, or breach-of-fiduciary-duty suits brought by a terminated Co-Founder or former Director who left the Board less than five (5) years ago; (b) claims brought by a Bankruptcy Trustee, Receiver, or Creditor's Committee; and (c) whistleblower or derivative actions where any Insured Person participates.

SECTION I.A. SHARED ENTITY LIMIT EROSION & MISSING NON-RESCINDABLE "SIDE-A DIC" TOWER.
The $3,000,000 Aggregate Limit of Liability is a single shared limit across Side A (Individual Directors & Officers), Side B (Company Indemnification), Side C (Corporate Entity Liability), and Employment Practices Liability (EPLI). There is NO dedicated Separate Side-A Difference-in-Conditions (DIC) limit for Individual Directors and Officers. Consequently, corporate entity defense costs or a bankruptcy stay on Side C can exhaust 100% of the $3,000,000 policy limit, leaving Founders and Directors with $0 of personal asset protection. Furthermore, Carrier retains the right to rescind Side A coverage for innocent directors if the Application contains any inaccuracy.

SECTION IV.A. NON-SEVERABLE CONDUCT, FRAUD & APPLICATION WARRANTY IMPUTATION.
For purposes of determining the applicability of Exclusion IV.A (Fraud, Dishonesty, or Willful Violation of Law) and the Application Representations Warranty, the knowledge, wrongful act, or financial misstatement of any Executive Officer (CEO, CFO, COO, or General Counsel) shall be imputed to ALL Insured Persons and the Company. Moreover, Exclusion IV.A is triggered upon "in fact" allegations determined by Carrier rather than a final, non-appealable adjudication in the underlying proceeding.

SECTION IX.D. AUTOMATIC CHANGE-IN-CONTROL TERMINATION UPON >50% EQUITY FINANCING OR M&A.
If during the Policy Period any person, venture capital syndicate, or entity acquires more than fifty percent (50%) of the voting stock or board appointment rights of the Company (including via a Series A/B preferred equity financing round or merger), coverage under this Policy shall immediately convert to run-off and terminate for all subsequent acts, with a mandatory 200% run-off tail surcharge required within 10 days.

EPLI ENDORSEMENT EP-08. THIRD-PARTY CUSTOMER EXCLUSION & $25,000 WAGE/HOUR SUB-LIMIT.
Employment Practices Liability coverage excludes all claims brought by third-party customers, vendors, or independent contractors alleging harassment or discrimination. Any claim alleging Fair Labor Standards Act (FLSA) overtime, meal/rest break, or independent contractor misclassification is excluded as to indemnity and capped at a $25,000 defense-only sub-limit.

100% Stateless & Private • Replaces a $2,500 – $7,500 D&O Counsel attorney review