RISKVUE ARCHIVE | FEATURE STORIES

Insurance Aspects of Mergers and Acquisitions

By James Reuter
Lindquist & Vennum, P.L.L.P.

Attention to insurance aspects of mergers and acquisitions often is too little, too late. It is common to handle insurance issues by relegating them to a few stock phrases of barely appreciated language in the agreement and then ignoring them after that. Any serious attention comes only at or after closing the transaction—sometimes to the ultimate vexation of one or more parties.

This is somewhat understandable because insurance can be esoteric and technical. Further, expertise may not be readily available. There is little authoritative writing about insurance issues in mergers and acquisitions, and relatively few claim experience and knowledge in this area.

A combination of trends, though, has made neglect of insurance issues ever more intolerable and increasingly risky. These trends include:

• The growth in number and complexity of insurance products,
• The unpredictability of court decisions about whether buyer or seller is entitled to insurance assets in the event of a claim,
• Today’s litigious climate,
• The increased size and complexity of claims and lawsuits,
• The high costs of defending a major case,
• The increasing number of “long-tail” claims where the alleged liability-causing conduct occurs years before a claim or lawsuit (commonly seen in product liability, asbestos, pollution, mold and silica claims), and, importantly,
• The amplified willingness of insurers to aggressively fight with insured businesses over insurance coverage issues.

Further, mergers and acquisitions are generally a business’ largest transaction. Substantial dollar amounts are involved. When a surprise uninsured major claim, lawsuit or cost comes along, those substantial dollar amounts may be at risk for both buyer and seller.

Together these factors compel early and enhanced early handling of insurance issues in large corporate transactions including mergers and acquisitions.

Insurance Provisions in The Agreement

There are no one-size-fits-all provisions regarding insurance that can be routinely used in merger and acquisition agreements. Several things can be said, though.

In the past, merger and acquisition agreements often stated that the seller has the risk of claims arising before the closing date and the buyer has the risk after closing, it being further stated or understood that each party would insure the risk they thought they had. For the reasons alluded to above, it may no longer be adequate to use this simple approach. Further, regardless of what else is stated about insurance in the agreement, at least from the buyer’s perspective, there ought to be requirements for production by the seller of documents and information about insurance. Specifically, those things that ought to be provided by the seller, among others, are:

• Complete copies of all insurance policies, including endorsements, schedules and amendments (how far back will depend on the situation)
• Copies of the most recent insurance applications
• A loss history, usually for 10 years but that may also vary
• Correspondence from insurers denying a claim or coverage
• Notices of cancellation of insurance policies
• Evidence of payment of premiums for the most recent policies
• Notices of audits or calculations of retrospective insurance premiums received from an insurer

Due Diligence

Like most other issues, the key to proper handling of insurance issues in a major corporate transaction such as a merger or acquisition is due diligence. For larger transactions, an insurance due diligence team ought to be formed. This team may be made up of insurance brokers, risk managers and attorneys for the parties. The due diligence team examines insurance documents and information produced by the seller and considers, for example, the following issues:

• What are the risks? Have they been adequately covered?
• Has the seller provided all policies? Are any policies lost or missing?
• Are the policies claims made or occurrence?
• Whether there are or have been any gaps in insurance
• Whether limits are adequate
• Whether insurance limits have been depleted or exhausted by prior claims
• Whether deductibles and self-insured retentions ought to be changed
• Whether notices of all claims and occurrences have been given to all appropriate insurers
• Have insurers denied coverage for any claims and what has been management’s response?
• What is the retroactive or continuity date on claims made policies?
• Are subsidiary and related companies covered?
• Are there joint ventures (that often need separate coverage)?
• Are premiums current?
• Will there be retrospective premiums payable in the future?
• Should the buyer combine any policies with the seller’s policies?
• If so, will there be policy cancellation penalties and how much?
• How will a merger or acquisition affect the workers’ compensation insurance experience rating and, thus, premiums?
• Have there been any notices of cancellation, policy amendments or reductions in coverage?
• Are the current policies written by financially strong insurers?
• Do the policies allow for purchase of an extended reporting period and on what terms?
• Should the buyer purchase prior acts coverage?
• Should subrogation be waived regarding pre-loss matters?
• Who will own the insurance assets and be responsible for existing and future claims, including claims that arose before the sale but are made after?
• Should insurance proceeds for any particular claims be assigned, providing the applicable law permits assignment?
• Should any of the parties purchase insurance for or as a result of the transaction itself, such as representation and warranties insurance, acquisition expense insurance, tax opinion insurance, pollution insurance, or one of several types of intellectual property insurance?
• Are there change of control provisions in the current policies that may require notice to and consent of the insurers before or at the time of the transaction between the parties? How will insurers respond to a change of control?
• Does the contemplated transaction itself pose a risk and should notice of it be given to insurers?

Conclusion

Thorough due diligence must also be applied to the insurance aspects of significant business transactions. Once due diligence has been completed, the parties are in a better position to consider various risk and cost shifting agreements in order to minimize risks and costs and maximize utilization of insurance assets. Obviously, while there may be resolutions that will benefit all parties to the transaction, there will likely also be differences among the parties. These differences will have to be negotiated. However, at least the likelihood of a nasty surprise will have been reduced by early attention to and due diligence regarding insurance. Armed with the results of that effort, each party can plan for good risk management and adopt an insurance program that best suits its own situation and goals.

ABOUT THE AUTHOR

James Reuter is a member of Lindquist & Vennum’s Minneapolis Insurance Coverage and Commercial Litigation groups. He can be reached at 612-371-3519; or e-mail jreuter@lindquist.com.

This article is only a general summary for informational purposes and does not constitute legal advice. Consult a qualified and experienced insurance advisor for your specific situation or particular questions.

riskVue | The webzine for risk management professionals
June 2005