Most fundamentally, consult key advisers, such as lawyers, accountants and underwriters, at the beginning of the process, not after the deal is done. They will help you understand the implications of both the assets and liabilities being purchased versus an asset-only purchase. The purchase agreement (PA) should then reflect your decision.
If only assets are being purchased, the seller should purchase extended reporting period (ERP) coverage for a sufficient amount of time to cover any future claims. The purchaser should also ask that the PA include a provision requiring the seller to purchase an ERP for their existing E&O policy and ask the seller to provide a copy of the existing E&O policy and the new ERP. If a claim develops in the future that is based on an act, error or omission committed prior to the sale, the purchaser has the ability to notify the seller’s carrier of the claim.
This arrangement means that the seller’s carrier—subject to the policy’s terms and conditions—must provide coverage for the claim because the purchaser did not purchase the agency’s liabilities. The purchaser should also ask for the PA to include a provision that the seller must “defend and indemnify” the purchaser for any claim that develops in the future based on an act, error or omission committed prior to the sale. Prior to the sale, the purchaser should also notify its E&O carrier to discuss coverage options for the soon-to-be acquired assets.
What can happen if this simple advice isn’t followed? The examples are plentiful, but two are illustrative.
In one case, an agency was named as a defendant in a lawsuit based on an alleged failure to procure coverage for a client prior to purchasing the agency. The agency was able to extricate itself from the litigation quickly with minimal legal fees and costs because the insured agency showed that the seller purchased a three-year ERP. Additionally, because the agency insisted on a “defend and indemnify” provision in its PA, they were able to recoup the legal fees.
In another case, an agency sold a professional liability book of business that contained a client—a law firm—that dissolved and purchased a three-year ERP for its lawyers’ professional liability policy. However, the agency chose to purchase only a one-year ERP. Two years after the sale, the agency was named in a lawsuit brought by the dissolved firm. The agency submitted a claim, but there was no coverage because the claim was made after the ERP had expired. They were on their own and had no E&O coverage to respond to the lawsuit.
Careful consideration should be made when selecting an appropriate ERP term. Selecting a term that is too short may save the seller money in the short run, but ultimately cost more if a claim arises after the ERP expires. A rule of thumb: The ERP should last at least as long as the applicable statute of limitations in your jurisdiction.
If both assets and liabilities are being purchased, the purchaser should contact their E&O carrier prior to the sale to discuss coverage options. Purchasing liabilities can be risky, and the potential implications should be considered carefully. Even with due diligence, the process has its limitations. The purchasing agency never gets the full story on its acquisition until it’s too late.
One thing is certain: Whether the purchase is assets only or includes liabilities, from the date of acquisition you own every mistake made on your watch, which often includes failing to find and correct errors made by your predecessor. “But,” you complain, “the mistake was made five years before I bought the agency!” True, but that mistake was made anew with each renewal, including the one that happened after the acquisition, so that’s on you.
It’s not uncommon for the acquiring agency to retain personnel to continue working the same accounts. It makes a lot of sense from a business continuity standpoint. But for catching errors? Experience tells us that if they didn’t catch them before the sale, those holdovers are not going to catch their own mistakes after the sale. Trust but verify. Use a second set of eyes to go through every account to confirm that the business was handled in a way that meets your agency’s standards.
You may have purchased a business, but that doesn’t mean you have to own its mistakes.
Kristina Miller is an assistant vice president with Swiss Re Corporate Solutions and works out of the Chicago office. Insurance products underwritten by Swiss Re Corporate Solutions America Insurance Corporation, Kansas City, Missouri, a member of Swiss Re Corporate Solutions.
This article is intended to be used for general informational purposes only and is not to be relied upon or used for any particular purpose. Swiss Re shall not be held responsible in any way for, and specifically disclaims any liability arising out of or in any way connected to, reliance on or use of any of the information contained or referenced in this article. The information contained or referenced in this article is not intended to constitute and should not be considered legal, accounting or professional advice, nor shall it serve as a substitute for the recipient obtaining such advice. The views expressed in this article do not necessarily represent the views of the Swiss Re Group (“Swiss Re”) and/or its subsidiaries and/or management and/or shareholders.
Copyright © 2023, Big I Advantage®, Inc. All rights reserved. No part of this material may be used or reproduced in any manner without the prior written permission from Big I Advantage®. For permission or further information, contact Agency E&O Risk Manager, 127 South Peyton Street, Alexandria, VA 22314 or email at email@example.com.