No matter how exhaustive the due diligence and planning performed ahead of a merger or acquisition, post-closing complications can arise. Undetected environmental contamination, disgruntled shareholders, fraud and unpaid liabilities may surface at a later date. Some of these risks are insurable and some are not. Regardless of which side of the transaction you are on, you should sit down with an experienced insurance advisor prior to the signing of a purchase or sale agreement.
Part of the motivation to sell may be to eliminate the considerable liability of owning and managing a business. At closing, the seller may breathe a big sigh of relief and then call their agent to cancel the insurance policies. In other cases, the parties may assume they can just pass the insurance policy rights from one to the other, but this type of assumption is nearly never acceptable to the insurance company.
Nearly all insurance policies address Merger & Acquisition (M&A) activity. A common clause says that if more than 25% of the stock changes hands, the policy is immediately cancelled as of the date of the transaction. At a minimum, policies will require that upon a triggering event, the insured will be required to notify the carrier, and the carrier will have the opportunity to charge additional premiums and change the terms of the policy. Before any stock transaction or M&A activity, this section of your policies should be closely reviewed. With a 60-day advance warning, your insurance representative should be able to review and, if needed, pre-negotiate terms with the carrier that will allow a smooth transition.
As a seller, what is the risk in letting your policies cancel at closing?
Here is an example of a post-closing complication: Shareholders take issue with the sale or merger. The shareholders may believe the price was not fair, the process was self-serving or other opportunities should have been explored. These disputes can happen on both the buying and selling side of the table.
Directors & Officers (D&O) Liability
Liability for directors and officers is typically a six-year statute of limitations. Normally the acquiring company is only responsible for actions from the date of the transaction going forward. So, sellers will often buy a “run-off” or “tail” policy to protect their directors and officers for acts that occurred prior to the sale. While run-off policies are available for one, three or six years, it is advisable to purchase six years to cover the duration of the statute of limitations. If you know that a transaction is on the horizon, negotiate the run-off well in advance when you have the most leverage; do not wait until the transaction is imminent. Also, prior to any stock or M&A transaction, consider reviewing your D&O insurance limits with an eye to the added risk that you are undertaking.
In all areas of M&A, planning is paramount; insurance matters are no exception. Be sure to consult with a trusted insurance professional to ensure you have all your bases covered.