M & A Insurance “What They Didn't Teach You in Business School”

During the excitement and mayhem of a merger, acquisition, sale or spin-off, the management team is required to consider myriad issues, many critical to the deal, while still running day to day business operations. The following list contains insurance related issues which can be crucial to the success of the transaction that will be discussed in this article:

A. Transaction Oriented Issues

• Representations and Warranties Insurance
• Aborted Bid Cost Insurance
• Tax Opinion Insurance

B. Existing Coverage Issues

• Directors and Officers Liability
• Employment Practices Liability
• Other Liability Issues
• Product Liability
• “Reps and Warranties Insurance” will pay those amounts the seller is legally obligated to pay including damages, judgments, settlements and defense costs arising out of an alleged breach of a representation or warranty in the transaction document.

Examples of reps and warranties which can be covered:

• Accounts Receivable
• Tax Liabilities
• Employee Benefit/Pension Plan Liabilities
• Inventory
• Saleable?
• Foreign Obligations

Policy coverage terms and conditions options:

• Pre or post transaction purchase
• Multiyear policy periods up to 10 years
• Limits up to $25,000,000
• Worldwide coverage
• Ability to choose own attorney

ABORTED BID COSTS INSURANCE

Anyone who has been involved in a transaction which took months to finalize only to have it fail due to factors out of their control knows that not only time, but a great deal of money has been expended. A new coverage has been introduced, “Aborted Bid Costs Insurance”, which can reimburse a firm for direct costs associated with an acquisition or other transaction that has been terminated due to:

• Regulatory Intervention
• Failure of other party to meet closing conditions
• Vote of disapproval by shareholders of other party
• Competing bid

Covered expenses include:

• Investment bankers
• Attorneys
• Accountants
• Consultants
• PR firms
• Lobbyists

The policy period would run for twelve months or until the transaction is terminated, whichever comes first. The applications must be filed within five days of the completion of the letter of intent.

Tax Opinion Insurance

Historically, companies have relied upon the opinions of their accounting and tax professionals, along with the private letter rulings from the IRS to determine if the tax consequences of an M & A transaction were in question. However, there may not be time to obtain the IRS private letter ruling.

Relative to the tax implications, the opinion of the accounting/tax professional may be one of the following:

• Slam-dunk; do the deal.
• Probably okay.
• More likely you should not do the deal.

In the first and third scenarios, the decision may be made easily. However, in the second, tax opinion insurance should be considered. It can be written to protect against the loss of anticipated tax benefits within a certain time frame or against specified adverse tax consequences. It is also important to note that there is no need to allege that the tax advice received was negligent.

In addition to the transaction-oriented coverages, there are a number of areas of existing insurance that must be addressed in the deal. Most of these issues revolve around claims-made policies, which I will discuss first.

Directors and Officers Liability

Studies have shown that there are more than twice the number of claims arising out of M & A activities than other causes, with an average cost over $7,000,000. While the policy of the surviving entity would cover actions occurring after the sale, any coverage the seller had prior to the closing ceases to provide coverage for their D&Os for actions prior to the transaction. Any claims for actions during the prior policy periods, including suits for the transaction negotiations themselves may be uncovered unless a “run-off” or “tail” policy is purchased.

Since many times the buyer wants the seller to continue for some period of time during a transition period, they encourage or require the sellers to procure this “run-off” or “tail” coverage for a period of time, typically three to five years. The allocation of the expense can be negotiated as one of the terms of the deal.

If it is your intent to sell your company as an exit strategy, it may be possible to negotiate the price and length of the “run-off” or “tail” coverage at the time the policy is issued. This would take some of the uncertainty out of the process at the time of the sale.

Employment Practices Liability

Often, part of the financial consideration of a deal is that duplication of some processes can be eliminated, thus reducing expenses. The seller is usually required to adjust the staff size prior to the closing of the deal. If the seller was prudent and had purchased EPL coverage, claims arising out of the requirement to “right-size” or “down-size” (choose your euphemism) prior to the conclusion of the deal may well be covered.

Like the D&O coverage, a properly structured purchase of “tail” coverage will be necessary to have the coverage in place for actions taken prior to the consummation of the deal. Again, the terms and pricing of this coverage may be done at the time of policy issuance.

Frequently, D&O and EPL coverage are purchased under the same insurance contract. If this is the case with your company, only a single negotiation will be necessary.

Other Liability Coverages

Similar issues apply to other specialty coverages written on a claims-made basis. This include Errors and Omissions coverage, also known as Professional Liability, Fiduciary Liability and Environmental Liability. Each has similar issues to those discussed above for D&O and EPL insurance.

Product Liability

There are two issues to consider under product liability. First, if you are selling just the assets of the company, you have an exposure going forward from suits brought about by bodily injury or property damage caused by your products after the close of the deal. Depending on the type of product(s) your company manufactured or distributed, a coverage called discontinued operations is available. Generally the insurer providing your product liability at the time of the sale would be the best source of the coverage, but other carriers would write the coverage as well.

Secondly, as a buyer, you may carry substantially higher product liability limits than the company you are acquiring. Coverage is available whereby you can retroactively buy higher limits to cover the product liability for the exposure of the products of the acquired company. This retroactive liability coverage can be a very prudent investment if the acquired company carried relatively low limits compared to the risk management practices of the acquiring company.

Recommendations

1. Keep a detailed policy log for an indefinite period of time. You may be surprised how little information is available from your insurance company or broker. The log should include the policy numbers, policy period, type of coverage and any special endorsements or deductible features. In addition, you may want to keep all of your liability insurance policies indefinitely.
2. If you are the buyer, have an M & A questionnaire completed by the other party providing historical information, including that listed above as part of your due diligence. Your insurance broker should be able to provide a comprehensive questionnaire for your use, or be able to facilitate the process for you.
3. Whether you are the buyer of seller, use professional advisors. They will be able to assist you in procuring the information you need to prevent those nasty surprises later. While there are other insurance issues to address, those described in this article are an excellent starting point. Experts in insurance, legal accounting and banking should be Able to guide you through the maze to successfully complete your transaction.

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Last Modified October 11, 2005