Professional liability claims implicating your errors and omissions (E&O) policy don’t always arise immediately—some can even be filed years after you’ve concluded your services for a client. So, if your firm is going through a transition, such as a merger or acquisition, it’s essential to identify how past liabilities will be managed. Consider the following questions:
- What happens if a claim involving past services arises three months or three years after the firm is dissolved, sold, or acquired?
- Who is liable—the seller or the purchaser?
- Would your existing insurance policy cover the claim or is an endorsement required to ensure coverage?
There are no simple answers to these questions, and the appropriate course of action for each firm will depend on how the transaction is structured and the liability is transferred to the purchaser. Will the merger or acquisition be an asset sale, conveying an entity’s assets and select liabilities to the purchaser, or an equity sale, conveying an entity’s entire assets and liabilities to the purchaser?
Given the complexities and multitude of factors to consider, it’s important to consult with your attorney, broker, and insurance carrier early on in the merger process to ensure your coverage needs are met. Proper planning in the beginning can help you avoid major problems at the end of a deal and ensure that any additional costs for required coverages are appropriately accounted for in the sale or purchase price.
When two become one
Since mergers combine two previously separate entities, it’s important to consider how the entities’ E&O insurance will be handled. For instance: how will each separate entity’s past exposures be managed? And what will the future insurance purchase for the merged entity look like? The answers are not as simple as merely purchasing a new insurance policy for the merged entity.
What complicates this process is the fact that E&O insurance policies are claims-made policies. This means that coverage is provided if (1) the policy is in effect when the claim is made and (2) the claim relates to a wrongful act committed during the policy period. In other words, the services giving rise to the claim were provided during the policy period. As previously noted, this can be problematic since claims can sometimes arise years after you finish working with a client and may not always align with the policy year in which you provided the services. That’s why prior acts coverage and tail coverage may be required.
Prior acts coverage extends your coverage to past acts or services that were provided before the policy period. The prior acts date determines how far back in time the coverage extends. Tail coverage extends the reporting period for claims covered by the policy into the future. The extended reporting period date determines how far into the future the reporting period extends.
To illustrate, let’s say that your insurance with Carrier A expires and a new policy is purchased with Carrier B on January 1, 2024. A claim arises on January 31, 2024, involving services you provided two years prior when you were covered under Carrier A. Whether the claim is covered by Carrier A would depend, in part, on whether or not you have tail coverage allowing for the reporting of claims for services previously provided, covering the January 31, 2024, period. Whether the claim is covered by Carrier B would depend, in part, on whether or not you have prior acts coverage for services provided in 2022.
Crafting the right coverage solution
There’s no set formula for crafting the right coverage solution to help you maintain continuous coverage. Your insurance broker and underwriter can help you determine the course of action that makes sense for your firm’s specific situation. Below are potential options to consider in those discussions with your insurance broker.
Hypothetical
Let’s say that Firm A merges with Firm B, with all owners, partners, members, and officers becoming part of the new Firm AB. Firm AB might explore the following three options:
Option 1:
Firm AB purchases a new policy for work it performs after the merger date, with no prior acts coverage. Firm A and Firm B each purchase individual tail coverage for claims arising from work performed up to the date of the merger.
Advantage: Each firm is responsible for its past exposures, leaving the new entity unencumbered by potential liability for prior acts.
Disadvantage: Since tail coverage for Firm A and B must be paid in advance, the up-front premium costs for both firms could be significant. Additionally, to the extent that Firm AB continues to render services to clients formerly served by Firm A or Firm B, claims may arise implicating both the former firm that served the client (Firm A or Firm B) and the new firm (Firm AB), possibly triggering coverage under two policies, each of which has a separate deductible that must be paid.
Option 2:
Firm AB maintains Firm B’s insurance policy and elects not to insure Firm A’s prior acts. Firm A is added to Firm B’s policy and Firm A purchases tail coverage.
Advantage: Firm B’s policy provides prior acts coverage for Firm B and covers the merged Firm AB going forward. Since there is no tail coverage or extended reporting period endorsement involved for Firm B, the initial out-of-pocket costs are less.
Disadvantage: Firm B’s past claim experience, if negative, could adversely impact the availability of increased limits of liability for Firm AB. Firm A incurs significant up-front costs in obtaining tail coverage.
Option 3:
Firm AB maintains Firm B’s policy and adds Firm A to the policy with prior acts coverage.
Advantage: Both Firm A and Firm B maintain prior acts coverage under one policy and the initial costs of the extended reporting period endorsements are avoided.
Disadvantage: Firm AB assumes all of Firm A’s liabilities without benefiting from the revenue earned from past services performed by Firm A. If Firm A has a negative claim history or inadequate internal controls, this increases the risks of a claim under the policy. Firm A’s continuing prior acts claim experience could also affect coverage availability and pricing under Firm AB’s policy even though Firm AB did not render the services at issue in the claim.
Each option has its advantages, disadvantages, and costs so it’s important to consult with your insurance broker or underwriter at the beginning of the transaction for guidance in crafting the right coverage solution for your firm and ensuring that the additional costs of required coverages are accounted for in the sale or purchase price.
Get it in writing
However you decide to proceed, make sure it’s documented in the agreement governing the merger or acquisition. Key terms to consider include:
- decisions about prior acts coverage;
- policy limits and deductibles to be maintained;
- responsibility for the payment of the policies and deductibles in the event of a claim; and
- what the rights and responsibilities of the parties are in the event of (1) the death, disability, or retirement of any of the principals, (2) de-merger, or (3) the dissolution of the new entity.
Detailing key terms ensures there is clarity regarding all parties’ responsibility for maintaining E&O insurance covering both past and future liabilities.
Proper prior planning
Insuring the entities during a merger or acquisition can be costly and complicated. That’s why it’s imperative to consult with your insurance broker and carrier early in the process. By identifying and addressing potential coverage concerns before the transaction is finalized, you can avoid expensive missteps and disputes. You can visit here or contact us at realestate.us@victorinsurance.com to see how Victor’s E&O policy may be able to help.
Victor and the National Association of REALTORS® have partnered under the NAR REALTOR Benefits® Program to provide a first-class errors and omissions (E&O) insurance program for REALTORS®. Several premium credits are available, as allowed by state law, including a credit for being an NAR member and/or holding select NAR designations. Receive a free quote today. Be sure to note your NAR Member ID on the application.
