M&A Insurance Considerations
In a situation when one company merges with another to become a single entity or when one company is acquired by another, it is imperative that both parties review and update their insurance covers to ensure all risks are accounted for. This article details the steps your company should take to prepare for a merger or acquisition and defines two types of insurance that may help your company reach a satisfactory closing with confidence.
Perform an Insurance Review
To make sure your company is not responsible for any surprise liabilities after a merger or acquisition transaction, perform the following review:
- Ensure all of the seller’s existing policies have sufficient limits and adequate cover for its main risks.
- Determine whether the seller has any potential liabilities that are not insured. To do this, review the seller’s claims history and existing policies.
- Take note of the seller’s existing contracts guaranteeing indemnification or agreeing to additional insured status for suppliers, customers or corporate affiliates of the seller.
- Review existing contracts to look for any indemnities or cover that may have been presented to the seller from other parties.
- Pinpoint new exposures that could reveal themselves if operations are added or moved to locations unfamiliar to your company. New covers may need to be purchased or old policies may need to be updated to make sure these operations are insured.
- Address any circumstances or conditions that could generate claims that would fall under the seller’s cover.
- Address any differences in the way the seller reported claims with the way the buyer reports claims.
Additional uncovered liabilities are often discovered in the due diligence process and the purchase price can be adjusted accordingly or the buyer granted applicable indemnification.
Warranty and Indemnity Insurance
During a merger or acquisition, certain discrepancies may appear in the way each company has represented itself. These inaccuracies could cause significant liabilities after closing that may not be covered by existing insurance policies. If the participating companies have not addressed this lingering liability and worked to reduce it, they should consider obtaining extra cover.
Warranty and indemnity insurance protects buyers or sellers of a company against breaches in representations and warranties. Insurers offer policies that are either ‘buyer-side’ or ‘seller-side’, referring, essentially, to which party is indemnified. This cover typically comes with the following advantages:
- Enables buyers to ‘top up’ a seller’s capped liability
- Removes the concern of not being able to collect on a seller’s promised indemnification
- Hastens a business sale by eliminating the need for escrows and by covering the liabilities of future representations and warranties claims
- Empowers buyers during an auction to place a bid with extra indemnification for the seller, making that bid stand out from the rest and thus look more attractive to the seller
- Allows a seller to fully and completely leave a business, if desired
- Makes it easier for the buyer to maintain a good relationship with the seller, who may become the buyer’s employee or business partner after the transaction
D&O Run-off Cover
If you have a directors and officers (D&O) policy, you know that it protects you from the costs associated with any legal actions, investigations or other claims brought against you. In a merger or acquisition scenario, the D&O cover of both entities needs to be examined prior to the completion of the transaction in order to ensure gaps in cover will not exist.
D&O policies are typically structured as ‘claims made’, which means the insurance does not cover the company after the policy expires. Therefore, if a claim is filed against the seller after the seller’s D&O policy expiry date, the seller will be responsible for paying any charges in full. Depending on the specific contract details, this could mean that the buyer is responsible for paying the fines.
Insurers can offer a ‘run-off’ policy that extends D&O cover (for a selected period) for any claims that arise after the seller’s policy expires. Companies should secure a run-off policy prior to the merger or acquisition closing.
Another factor to examine in D&O insurance is the ‘change in control’ provision. Many D&O policies include a ‘change in control’ provision that modifies or voids the cover if the company is merged into or acquired by another company. Insurers will typically use a change in control provision to limit cover to wrongful acts occurring prior to the change in control.
Do Your Homework
Merger and acquisition deals can be complicated. You must undertake extensive research and preparation prior to deals closing to ensure that there are no gaps in insurance cover. When preparing for a merger or acquisition, it is crucial to understand how the buyer’s and seller’s policy will respond to a change in control and to secure run-off cover for any claims made following policy expiry dates.
In order to avoid saddling your combined company with uninsured liabilities, you must be knowledgeable about your insurance policies and how each might be modified in a merger and acquisition transaction.