Mergers and acquisitions (M&A) have become an influential business strategy as leaders look for opportunities to accelerate growth and gain market share. As these transactions happen in a more condensed time frame than ever, all parties are rushed to perform proper due diligence. Don’t let a merger or acquisition void your insurance coverage,
The following are potential hidden M&A insurance risks and liabilities you should consider.
Accept a Seller’s Liability
A pressed M&A process increases the buyer’s risk of neglecting the seller’s liabilities. The responsibility for alleged or actual wrongful acts does not terminate with the transfer of ownership. These exposures can exist for many years following the transaction.
The type of sale determines the extent to which liabilities are assumed. A seller retains possession of the legal entity and its liabilities in an asset sale. Only individual assets (e.g., equipment, trade secrets, inventory, licenses) and their accompanying liabilities are transferred to the buyer. Asset purchases are preferred as they reduce the likelihood of future contract disputes, product warranty issues, or product liability claims.
In a stock sale, the buyer purchases the selling shareholders’ stock directly and obtains ownership of the seller’s complete legal entity, including all accompanying liabilities. Stock sales present more risk for buyers as there is a potential for future lawsuits, environmental concerns, employee issues, or OSHA violations.
The best liability protection in an M&A is to partner with your insurance broker to update your insurance policies and indemnifications.
Organize & Update Insurance Policies
Depending on the circumstances, a buyer could combine their insurance policies with the sellers. Unfortunately, this can be tricky as tracking multiple policy discrepancies across various lines of insurance, policy limits, exclusions, and deductibles is challenging. Insuring all risks for both companies could be cost-effective and convenient. Consolidating policies will allow the buyer to evaluate the seller’s value limits and deductibles and determine if they are well-suited for the merged entity.
Change in Control Provision
An often overlooked aspect in an M&A is the insurance policy’s change of control provision. A change in control, or transaction condition, arises with a change in the majority interest of the insured company. This will occur when a person, entity, or group acquires/merges/consolidates and possesses more than 50% of the capital and voting rights. This power transfer can immediately trigger termination or conversion to run off the acquired company’s liability coverages. Your business can also be liable if you neglect to report to your carrier any merger, consolidation, acquisition, or other changes in the control of the business. A failure to notify the carrier of the transaction could reduce or eliminate coverage under the policy.
When a business is merged or acquired, the buyer takes possession of assets and the seller’s liabilities. A buyer could demand the company being assumed purchase runoff insurance as protection from these risks. Runoff insurance will cover an acquiring company from legal claims against the business that has ceased operations. The policy applies for a certain time period after the policy is active and performs as a claims-made policy. Runoff policies are similar to extended reporting period provisions, except they lengthen beyond an annual renewal.
Directors & Officers (D&O) Risks
Many directors and officers are unaware their D&O insurance will either automatically cancel or provide substantially limited coverage following a change of control or transaction event. Regardless if the directors and officers remain the same, the mechanics of the D&O insurance will automatically prevent coverage for anything that results after the event date.
D&O policies are typically structured as claims made, meaning the insurance does not cover the company succeeding the policy’s expiration. Any claim filed against the seller following the D&O policy expiration date will obligate the seller to full responsibility for compensating any charges in full. Depending on specific contract details, the buyer could be responsible for footing the bill.
Buyers must consider that the seller’s directors and officers may need to be added to the buyer’s D&O policy. The seller’s policy will only provide coverage for actions that transpired when those directors and officers were executives of the acquired company. New coverage is required for any future actions of the board of directors following the merger or acquisition completion.
Ask the Right Questions
- Making inquiries, even when complicated or uncomfortable, helps a buyer reduce risks and determine an accurate purchase price. Here are some questions that are not always asked but should be:
- Are there legal and financial risks attached to this merger/acquisition, and if so, what are they?
- Does the acquired company’s insurance policies have term limits that can sustain future financial liabilities and any others that might occur from past activity before the transaction?
- What are the specific terms and conditions in the D&O policy of the acquired company?
- Does the D&O policy have any statute-of-limitation clauses?
- Does the company’s post-transaction risk summary look different from before the purchase?
We’re Here to Help with Your Risks
Managing the hidden risks during a merger or acquisition may seem daunting. We focus on providing our clients with the right information and support to make business decisions that best protect their company. ( Feel free to contact me – firstname.lastname@example.org )